Paul Craig and Rasmus Soegaard
Portoflio Managers at Cirilium
With Boris Johnson’s unprecedented proroguing of UK parliament, six consecutive defeats in the House of Commons, and a Supreme Court ruling against the government, which declared the prorogation was unlawful, the prospect of a ‘no-deal’ Brexit has become very real.
With political storms raging in the UK, Paul Craig and Ras Soegaard answer some of the Brexit questions that are foremost in the minds of investors.
Q What’s been the impact of Brexit so far?
“Thanks to the latest round of political intrigue in Westminster, the threat of a ‘no-deal’ has drawn that much closer. The UK’s headlines have been consumed by the drama making Brexit impossible to ignore for UK residents."
“Since 51% of the UK electorate voted to leave the EU in June of 2016, this trip into the unknown, and the uncertainty it’s created, has torpedoed the value of sterling. In early June 2016, a pound was still worth $1.45. The shock referendum result saw sterling fall 8% against the dollar and 6% against the euro (on 24 June 2016)."
“Since then, it’s lost a further 19% and 16% respectively against these currencies. “Within four months of the referendum a pound was worth just $1.22. It touched the same levels at the start of September 2019 following the proroguing of Parliament and has dipped still lower since."
“Buoyed by the weakness of sterling, the UK stock market has soldiered on since the referendum returning around 28% between then and the start of September 2019. Even so, UK equity returns during the Brexit era have fallen far behind those of US and, by extension, global equity indices."
“Thanks to Brexit, UK equities are unloved by overseas investors. Since the referendum, they’ve withdrawn almost $30bn from UK funds with more than $4bn being pulled since Theresa May’s departure. This is reflected by undemanding UK valuations that are at 20-year lows relative to the US. The yield on the FTSE All-Share is now the highest since the financial crisis 11years ago (4.75%), while the FTSE 100 yields 5%.”
Q How has Brexit shaped your investment approach?
“Cirilium has always favoured a diversified approach across asset classes and geographies although, so far this year, it’s been a two-horse race: US equities and developed market government bonds."
“At the portfolio level, we’ve expressed our views on Brexit by remaining broadly underweight to the UK preferring instead to go overweight to markets like Japan, Asia and emerging markets where we see more value. Within our UK allocation, we’re significantly overweight to companies that are more reliant on the domestic economy because our underlying managers see the best opportunities here."
“Many UK mid and small-cap stocks have underperformed since the referendum, but now look laden with value. The catalyst that releases this value is likely to be the resolution of Brexit.”
Q How worried should I be as a private investor?
“As a global, multi-asset portfolio investor, Brexit is just one of a number of investment concerns. To a certain extent, the Brexit outcome is binary. The challenge for us as portfolio managers is to make sure we’re covered whatever direction Brexit takes."
“According to the Bank of England, a disruptive ‘no-deal’ Brexit could send sterling crashing to well below dollar parity. If it does, the UK’s biggest stocks will have a field day as around 75% of the FTSE 100’s earning derive from overseas."
“However, if a viable deal somehow emerges in the coming weeks, sterling’s likely to leap. This would initially weigh heavily on the UK’s big exporters and would likely trigger the outperformance of the smaller, more domestically focused, UK companies where, thanks to our underlying managers, we’re notably overweight.
“However, a positive deal would also improve the economic outlook significantly the OECD is currently predicting that the UK will crash into recession if a ‘no-deal’ emerges. With a greatly improved macro outlook, UK company earnings will improve, and we may see overseas investors finally returning to the FTSE. If this happens,UK large cap stocks will also take off again, so we still have exposure to quality larger UK stocks."
“Of course, if sterling rallies significantly it will reduce the value of our overseas holdings that are denominated in other currencies. Fortunately, a significant proportion of the Cirilium portfolio’s holdings are hedged back into sterling, so our investors shouldn’t suffer any significant loss in relative performance if the pound suddenly races away."
“In the meantime, after three years of intrigue, Brexit has become ‘business as usual’ for most British companies. None of the UK portfolio companies we visited this year pointed to Brexit as a major concern. Like us, they’ve prepared the best they can, based on the information they have and, like us, they’re ready to adapt if the situation changes. All this means that you can’t affordnot to have an allocation to the UK in a global portfolio right now, despite the obvious headline risks.”
Q What's the best-case scenario you can currently envisage for Brexit and what's the worst?
““A best-case scenario for the UK would be if politicians somehow found a workable agreement that prevents a ‘no-deal’ departure. Whether Mr Johnson’s ‘hard-ball’ tactics payoff remains to be seen, but with both Germany and Italy facing recession and the EU’s second largest export market about to depart, a deal could still be done."
“Especially as numerous senior roles are now up for grabs in the EU’s sprawling bureaucracy. Currently, we’re heading for the ‘worst-case’ scenario. Mr Johnson has done his utmost to lock the UK into an unnegotiated departure that would leave companies on both sides of the divide struggling to understand their obligations. We won’t know until October, when the ultimate deadline is threatening, whether this proves to be Mr Johnson’s ace in the hole.”
Q How do you look past the short-term noise to deliver the long-term outcomes your clients are relying upon?
“For now, we’ve made our tactical decisions about how to handle Brexit in the context of our global portfolios and we’re reassured by the stress testing that our underlying managers have been performing, but we’re monitoring the situation as it develops".
“Broadly speaking, life’s getting tougher for portfolio investors, but we don’t see a global recession or any other systematic threats on the horizon, so we’re remaining invested. There may be some heavy weather ahead, but we’ll continue doing what we’ve always done, keeping portfolio risk nailed down and taking advantage of the pricing opportunities that present themselves as volatility rises.”
UK: Suitable for retail investors
Rest of Europe and Singapore: For sophisticated investors only
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