Investment Newsletter June 2016
EU referendum update Mike Deverell Investment Manager
As we get closer to the EU referendum, markets are getting more and more nervous. A month ago it looked quite likely the referendum would result in a “remain� vote. However, recent
opinion polls have changed direction and now many polls put the leave camp ahead. The chart below shows the trend in the poll of polls (source: www. whatukthinks.org). The latest figures show 52% in favour of leaving the EU:
Graph shown as of 17/6/2016 Equilibrium Asset Management LLP (a limited liability partnership) is authorised and regulated by the Financial Conduct Authority. Equilibrium Asset Management is entered on the Financial Services Register under reference 452261. The FCA regulates advice which we provide on investment and insurance business; however it does not regulate advice which we provide purely in respect of taxation matters. Copyright Equilibrium Asset Management LLP. Not to be reproduced without permission.
Investment Newsletter June 2016
We all know the flaws in opinion polls after last year’s election and betting markets are still telling a different story. For example, Predictwise.com is currently giving a 63% chance of the result being to remain in the EU. However, even that is well down on the greater than 80% chance implied by betting markets a month ago. The chart below shows how the momentum has shifted relatively recently (remain is the red line):
We have therefore decided to make small reductions in equity, property and fixed interest, increasing cash holdings. In our balanced model portfolio we have reduced each of the asset classes by approximately 3%. Other models and bespoke portfolios will have had slightly different reductions. Should there be a Brexit vote then this cash will help portfolios weather the inevitable storm, and then take advantage of opportunities should markets overshoot. Should the result be for the UK to remain in the EU, then we think markets may recover. We believe this is the most likely result but we also feel we should hedge our bets. Most clients have told us that they would rather give up some potential gains in the short term, in return for further protection should markets slide.
Graph shown as of 17/6/2016
We have generally taken a somewhat cautious stance in the run up to the referendum with slightly less in equity than usual. We have also reduced UK commercial property which is already showing signs of vulnerability due to reduced investment flows. However, given the increased chance of a win for the “leave” camp and the potential impact this could have on many asset classes, we have decided to take an even more cautious stance in the short term. Markets have reacted sharply to the change in momentum and this has started to affect many asset classes. Interestingly, the concern is being felt globally rather than just in the UK or even the EU, with the US Federal Reserve and Bank of Japan citing Brexit as a reason for not changing their monetary policy just yet. Initially, only Sterling showed much sign of sensitivity but stockmarkets have become much more volatile and the recent decline in investment into UK commercial property is partly due to Brexit concerns. Higher yielding corporate bonds have also slightly weakened in the last week or so. In particular, concerns about the result are feeding into the perception of risk in the banking sector which could be particularly vulnerable.
In the event of a “remain” vote we are likely to reinvest some or all of this cash. Of course markets might have moved sharply upwards relative to when we sold but we believe the overall impact would be limited. For example, a fairly extreme but possible scenario could look something like the following: • • •
Equity markets recover by 5% Property funds reprice back up by 5% as investment flows recover Fixed interest funds go up by 2%
With a reduction of 3% from each asset class, the total impact of this scenario on a portfolio would be lost returns of 0.36%. We believe it is unlikely we would see such a combination of events and so even if markets move up whilst we hold additional cash, most likely the impact would be less than in the above scenario. We always emphasize that our role is not just to chase returns but, where appropriate, take steps to protect capital. It is always a fine balancing act between risk and potential return, but right now we think it is wise to focus on reducing risk. We will keep you updated with future developments and will issue further communication after the referendum result is known. * Since we originally wrote this newsletter, the polls have swung again and momentum has moved back towards a “remain” vote, with a corresponding bounce in markets. However, this highlights just how quickly things can change and why we therefore believe a cautious stance is warranted.
Equilibrium Asset Management LLP (a limited liability partnership) is authorised and regulated by the Financial Conduct Authority. Equilibrium Asset Management is entered on the Financial Services Register under reference 452261. The FCA regulates advice which we provide on investment and insurance business; however it does not regulate advice which we provide purely in respect of taxation matters. Copyright Equilibrium Asset Management LLP. Not to be reproduced without permission.
Market Views June 2016
General Economic Overview Global growth remains weak. Recent headlines have been focused on the EU referendum with investment in the UK somewhat drying up, and some investors shifting funds out of UK assets. This could have an impact on UK growth. Inflation remains low but could move sharply higher in the UK if sterling continues to weaken. Rates are likely to remain on hold in the UK for the foreseeable future, and the Federal Reserve in the US is also holding back on this decision. Things have improved in emerging markets, partly as a result of a rebound in commodity prices. Asset class key + positive - negative = neutral (normal behaviour)
+5 strongly positive -5 strongly negative
Asset Class
Score
Equity Markets This score is slightly increased from last month after a recent drop in markets, though if there was a “leave� vote in the referendum we would expect a further downturn. Most stockmarkets are fair value but corporate earnings growth remains patchy and this is likely to somewhat limit future equity returns.
-1
Fixed Interest Our score is -1, slightly up from -2 last month. Nervousness amongst investors has increased the short term attractiveness of the safest bonds, but overall we still prefer to lend to companies than governments where we can receive a much higher yield.
-1
Commercial Property Returns from commercial property continue to slow and there has been significant lack of investment of late. We believe returns from property over the next 18 months will be driven primarily by the level and growth of rental income, with little capital growth.
Cash With interest rates remaining at record lows, returns on cash will remain below average for the foreseeable future.
-3 -5
Balanced Asset Allocation For a typical balanced portfolio we are underweight fixed interest, equity and property. This is balanced by additional holdings in defined returns, alternative equity and tactical cash.
A neutral score (=) means we expect the asset class to move in line with our long term assumptions: 10% pa for equity, 7% for property, 6% for fixed interest, and 3% for cash. A +5 score means we think the asset class could outperform by 50% or more. A -5% means we think it could underperform by 50%. A negative score does not necessarily mean we think the asset class will fall.
These represent Equilibrium’s collective views. The value of your investments can fall as well as rise and are not guaranteed. Investors may not get back the amount originally invested. We usually recommend holding at least some funds in all asset classes at all times and adjust weightings to reflect the above views. These are not personal recommendations so please do not take action without speaking to your adviser. Equilibrium Asset Management LLP (a limited liability partnership) is authorised and regulated by the Financial Conduct Authority. Equilibrium Asset Management is entered on the Financial Services Register under reference 452261. The FCA regulates advice which we provide on investment and insurance business; however it does not regulate advice which we provide purely in respect of taxation matters. Copyright Equilibrium Asset Management LLP. Not to be reproduced without permission.