June, 2016 |

“Difficulties mastered are opportunities won”

An Investment Manager’s Perspective

“Difficulties mastered are opportunities won”. Winston Churchill famously uttered these words in a speech on 21^st March, 1943, at the height of the Second World War. As we have seen, the UK has been thrown into a state of flux following Friday’s vote. However, as always, this also represents opportunities; the question is how to take advantage of those?

As many of our clients hold Wellian portfolios, we decided to speak to Richard Philbin, Chief Investment Officer at Wellian Investment Solutions earlier this week.

Although this absolutely does not constitute a recommendation to invest in Wellian (we are of course, independent and use a range of investment firms), we thought it might be helpful to hear their house view on the decision to leave and how that may impact decisions taken in relation to their portfolios.

So we asked Richard (RP) a number of questions:

Richard Philbin image — Richard Philbin, Chief Investment Officer, Wellian Investment Solutions

CG – Had you known the result in advance, how would you have positioned the portfolios?

RP – Hindsight is a wonderful thing. We are longer term investors and have been changing the shape of the portfolios for quite some time now – it is better to close the stable door BEFORE the horse bolts. We also build portfolios to be diversified across geographies, styles, asset classes and so on, whilst still being very mindful of the risk profile and investment objectives of the underlying client. We often use the following (potentially flippant) saying “if you’ve bought a toaster, you expect it to cook bread, you don’t expect it to change into a washing machine.”

We build and monitor our portfolios to meet defined risk boundaries as well, and had been aware that correlations and risks were rising in the UK, so we reduced UK exposure to a number of funds. In a couple of models we increased our cash weight too.

With perfect hindsight, you would be fully weighted in equity until Thursday night and then go short Sterling, and correspondingly long US Dollars (USD). You would have increased exposure to gold. Then, this morning (28^th June) you would have gone back into the market….

I guess the question could also be phrased along the lines of “how far in advance would we have known the outcome?” Our models have performed very well over the past couple of days – our funds are not 100% exposed to the UK stock market, and even though we do have some exposure to the domestic market which has hurt, we have been increasing our international holdings and diversification which would have benefited from the currency weakness. A good example would be the purchase of Fundsmith Equity which we placed into a number of models almost 5 months ago. It accounts for instance 8% in the Growth model.

CG – How are investment managers taking advantage of this uncertainty?

RP – A very good question. I have been talking to a number of fund managers in the last couple of days; collating their views and thinking about the future, and the vast majority are talking about “caution.” The dust is far from settled – politically the Conservative and Labour parties are rudderless, Article 50 – the now famous Article 50 – has not yet been invoked, and there is no precedent regarding how a European “divorce” will happen. All we know is that it will take some time and not be painless.

Some indices have sold off dramatically – especially the Small Cap and Mid 250 indices, and within these there have been some large movements – stocks within the retail, real estate, construction sectors (and many more) for instance are down greater than 20%. Some approaching 50%. This means there will be opportunities – for domestic as well as international buyers (just think – US investors can now gain an extra 10% due to currency movement alone…)

In the large cap space, insurance and banking stocks have taken a beating – financial services is seen in the immediate term to likely be a large “loser” and that is not too surprising all in all. The fear of inflation, interest rates, corporate failure, bad debts and so on weigh on the mind of the market.

There will be opportunities – the market is both “a weighing machine as well as a voting machine” when it comes to share prices.

Liquidity seems to be fine (unlike 2008) which should give some comfort to market participants. I only know of one major “winner” – Crispin Odey – who runs a hedge fund – where his portfolio was up greater than 15% on Friday alone. But, his fund is still massively down on the year….

CG – In light of the decision, do you foresee any immediate portfolio changes?

RP – I don’t think “immediate” changes are on the cards – we will closely monitor the situation. I would imagine over the next couple of months though that we might increase our exposure to the UK due to the benefits already gained from the weakening currency and the recent stock market sell-off. We do not know if the sell-off witnessed on Friday and Monday is a knee-jerk reaction or the start of something greater. Fortune favours the brave, but I don’t think it is our job to be super “brave” at the moment.

Our portfolios are diverse and we will have had some funds deliver excellent numbers as well as some that have disappointed. But, we are happy with this approach and aim to deliver outperformance over the medium to long-term.

CG – The biggest casualty to date seems to be Sterling. How have portfolios been affected by this?

RP – It is very interesting to see that Sterling has been the main “casualty” of Brexit. The Bank of England is independent and has the ability to print money. Over the past 12 months or so Sterling has weakened against most currencies – the Euro and the US Dollar especially. Of course our funds would have taken some impact from having UK holdings, and to a certain extent, the old “pound in your pocket” saying still remains. We have been increasing our international holdings over the past couple of months, and the translation effect of Dollars to Sterling or Euros to Sterling will have positively impacted returns.

It is (sorry for sounding like a stuck record here) still very early to say whether the short-term weakness in Sterling will become long-term weakness, but companies that export will be beneficiaries and the UK does operate within a global marketplace. Japan has been trying for years to weaken their currency and would love to see the Yen fall to such an extent.

CG – Looking forward, what are the key points for clients to be optimistic about?

RP-

The UK stock market has a great deal of businesses that are both inward and external looking when it comes to revenues, profits and therefore there will be winners in this recent “turmoil”. We have global leaders in many market segments and there will be opportunities.
When markets sell off, dividend yields rise (although you need to be mindful of pay out ratios.) With interest rates low, inflation muted (but this could change if Sterling remains weak) and yields on gilts touching less than 1% yesterday for the 10Y Treasury, sometimes taking risk when others are taking cover could provide a very timely investment return.
Interest rates could fall at the next BoE meeting (July). Low interest charges can be translated into higher profits.
The UK is very entrepreneurial in spirit. (Potentially) less legal constraints due to Brexit can free up innovation
The UK is still 0:00 on GMT. We speak the global language of business and have some of the best laws in the world. London is a global city and will always attract foreign money – whether that be for business, property or leisure spend. It’s now 10% cheaper to come… Maybe the leisure industry will be a big winner.

Although we are going through a turbulent time, it is precisely these moments that can create opportunities. It is important though to make sure you are as comfortable as possible with everything that’s going on – remember your plan and work it patiently.

We are always happy to answer any questions you may have and to discuss any concerns you or your friends and family may have.

“If I go there will be trouble” (The Clash)

So we have voted to leave – what happens next?

After months of campaigning, the UK has finally voted and whilst the result has been extremely close, many will be shocked at the decision to leave. Following on from Michael’s note last week, we have put together this short article looking at the consequences and potential impact of Brexit.

Market Reaction

Unsurprisingly, initial market reaction has been negative given that sentiment in the days preceding the referendum seemed to be swinging in favour of a Remain vote. As expected, the FTSE is down approximately 4% at time of writing and Sterling has fallen by approximately 6% versus the Euro and 8% against the Dollar.

It would seem that the prospect of protracted uncertainty across the UK and Europe means volatility will continue and coming weeks and months will be difficult for fund managers and small and mid-sized UK based businesses. However, it is important to remember that many of the companies listed on the UK Stock market, particularly those in the FTSE 100 are global companies and as such may be protected to a certain extent due to their relative lack of domestic economic exposure.

Political Repercussions

Statistically at 17.4m, the vote to leave was approximately 1.3m larger than the Remain vote. That said and even with a turnout of 72%, some 13m people didn’t vote which is 10 times the size of the Leave win.

Although the choice was binary – “yes or no,” there is no doubt that the possible consequences arising from the decision are far from binary. Already we have seen David Cameron resign, raising the prospect of a leadership battle within the Conservative party and all that may bring (could we see Boris Johnson finally make his play?); Alex Salmond call for a further vote on Scottish Independence and in Northern Ireland, we have heard Sinn Fein call for the opportunity to allow the population to vote for a separation from the Union and look towards a United Ireland.

Although these calls present risks, they are not unexpected and in reality any decisions regarding the future of the Union ought to be viewed as possible on a longer term, say 10-year horizon.

Economic Consequences

As already alluded to, the economic consequences of this decision are not clear. If we look specifically at the regions of the UK, the impact could be significant. Scotland can set its own tax rates, but we have already seen Wales asking for money to replace what it will lose from the EU. Northern Ireland is a net beneficiary of EU money and so that money will have to be found from somewhere either in the form of extra taxes or extra borrowing with consequences for the economy as a whole. Only time will tell what the impact will be as the shock of the decision dissipates over time.

Some commentators have suggested that the vote in favour of leaving (52% v 48%) is relatively narrow and allows the possibility that the UK will retain access to the single market through membership of the European Economic Area. However, this depends on negotiations with the EU and could mean free movement of labour would continue across the EU… plus ça change, plus c’est la même chose…(the more things change the more they stay the same).

We should remember that the Bank of England and other institutions have worked out their contingency plans in the event that the country voted to leave. This was particularly evident in Mark Carney’s speech earlier today when he explained the plans that have been put in place to protect the UK and UK business as far as possible from the potential fallout caused by a Leave vote.

Our Message

Whilst this decision is the most important in a lifetime, I go back to the point we made in a previous commentary. The sun has still risen this morning, Wimbledon will still begin on Monday and Northern Ireland will still beat Wales tomorrow afternoon. The move to divorce ourselves from the EU will take a considerable amount of time, with more becoming clear in coming weeks and months.

At Greenstone we advocate three key principles:

Have faith in the future – At the moment, the FTSE 100 stands at 6,038. However on the day I was born it was 149.76 (please don’t ask when. It was a long time ago!). There will always be some crisis or other around the world that impacts on markets, but if we believe they are broadly efficient and capitalism works, then the long term trend is upwards.

Have a plan and work it patiently for your lifetime and if appropriate, the next generation. None of us are in this for the short term.

Have patience – Have a plan and work it patiently for your lifetime and if appropriate, the next generation. None of us are in this for the short term.

Discipline – Avoid doing the WRONG thing. At times like this it is easy to be caught up in the broader sentiment. Keep a cool head and speak to us if you are worried about your investments.

As always, any uncertainty presents opportunities and we will continue to work with you to make sure your plan stays on course whatever happens in the short term.

However, we appreciate that you may have more questions about how this is likely to impact you personally, so do please feel free to contact us in coming days and weeks.

Brexit – “Should I stay or should I go?”

What Brexit will mean if we decide to ‘leave’ or ‘remain’

With just days to go until one of the most important decisions in a generation, we thought we would add to the mountains of commentary on the vote. Greenstone does not have a house view on which way people should vote and therefore this missive is not to sway opinion one way or another, rather to offer comment on the claims and look ahead to what the landscape might be on 24^th June.

The case for Leave (“If I go there will be trouble…”)

This is clearly the more vocal of the campaigns; one cannot help noticing the number of posters encouraging us to vote out. Their central case seems to revolve around three pillars; regulation, sovereignty and immigration. The belief is that if we were to leave the EU, we would be able to take control of our own destiny and cut the red tape which is holding British business back. It would also allow us to negotiate trade deals with the rest of the world which would boost exports and reduce our trade deficit.

The subject of immigration dominates debates however and is a key issue for the leave campaign. Many in the UK remember the claims regarding tens of thousands arriving from Poland and the new joiners in 2004 and the resulting 1million+ which came over has made many cynical of future immigration claims. The fact that the Polish in particular have integrated well into society and particularly the economy, seems a given but irrelevant for their argument. The fact is we had no control over the inflows.

The case for Remain (“…And if I stay it will be double”?)

As with the Scottish referendum, campaigning for the status quo is hardly the most inspiring message. It has been dominated by fear of the unknown and tales of perilous economic hardships if we leave. Their message is that the EU is a long way from perfect, but it is a case of better the devil you know. They also point out that it is better to be involved and try to reform it from within than sit on the side lines, still being affected by its decisions but having no say.

Whilst not saying that the UK is a lesser economic and military power than it used to be, it talks up the virtues of collective bargaining and that being part of a group of 500 million people adds weight at international negotiations. The main argument however surrounds the economy and the belief that a Brexit will curb demand of UK services, particularly in the financial sector, which are vital to our economy.

How to decide?

The problem with such an important decision is that it effects so much, it is impossible to quantify the costs and benefits of either option. There is more clarity around what a remain vote will bring, as effectively there will be little change. However, in our view the arguments for voting for or against are as follows:

Remain – You believe the EU has been good for Britain, Europe and the World. That the UK is stronger when working closely with our neighbours and there is better opportunity for trade by remaining part of the Single Market. The overriding reason however may be fear of the unknown or shorter term market volatility.

Leave – You believe the EU has not been good for Britain, that the EU’s free movement of people has caused a strain on housing and public services. That we are better off trading with the rest of the world and remain a big enough power to command bilateral trade agreements with India, China and the US. The overriding factor may be that you are concerned about immigration and wish to restore sovereignty.

Myths, half-truths and unknown unknowns

As we mentioned, it is nigh on impossible to say what the specific costs and benefits may be of either vote given that membership of the EU affects so many parts of our lives. Both camps have been guilty of making claims backed up with little evidence or worse, ignoring statements and official opinions of professional bodies.

As mentioned, the remain camp has been based largely on scaremongering and they have employed some ludicrously exact claims of a cost of exit. There was a precise figure of how much worse-off households will be in over a decade’s time, that unfortunately mixed up household income and national income per household. There were also figures on the increased cost of one’s holiday to Tuscany this year!

The leave campaign has had its share of questionable statistics, though its main tactic has simply been to ignore the official voices. Almost all financial and business institutions, from company owners to banks, central banks and organisations such as the IMF, have said Britain is better off in the EU. The leave campaign has simply retorted ‘they would say that, wouldn’t they’. This appears to be an effective argument as a large portion of the population is mistrusting of such official opinions. It has allowed the leave campaign to claim that there will be less immigration, even though most of our immigration comes from outside the EU; that it would stop Brussels setting so many new laws despite the fact that new legislation is largely home grown; and that we can have a trade deal with the US despite the American President himself denying such a claim.

What will 24th June look like?

Whilst it is easy to become caught up in the hype, come the morning of the 24^th June, the sun will rise, people will go to work as usual and England will no doubt be heading for an early exit from the Euros. It will be in the days, months and years that follow in which the true repercussions emerge. Below are what we think might occur in the weeks that follow either result.

Brexit – The FTSE 100 is likely to fall sharply as markets wake up to the news that uncertainty remains. The pound will also likely fall against most other currencies, though the fall against the Euro may be tempered by the Euro’s own fall in value as the EU as a whole looks less attractive to investors minus Britain.

It is likely that David Cameron would resign and as the party elects a new leader, gilts may come under pressure as international investors weigh up Britain’s economic future. This in turn would push up the cost of borrowing and could trigger a recession.

Longer term of course, we may negotiate a number of bilateral agreements with the rest of the world, allow only the best and brightest into the UK and cut red tape for business, generating a highly productive, exporting economy and a shrinking welfare bill, leading in turn to lower taxes. Of course, a vote to leave would still need to be approved by parliament and, although unlikely, it could be blocked if enough pro-EU MPs were prepared to go against the public will.

Remain – There may be a small relief rally in markets and Sterling could strengthen against major currencies. If it is a close vote there could still be a vote of no-confidence in the Prime Minister, putting pressure on gilts, but that is less likely. The housing boom may well resume as foreign investors who paused their purchasing plans start buying again. There may even be a bounce in GDP as companies deploy investment which they have held back in new machinery, marketing and employment.

Over the longer term the risk is that there is a wave of immigration which we cannot control and therefore puts further strain on welfare and public services. It may also be that increasing involvement from Brussels affects the competitiveness of our industry and service sectors which, combined with the pressure on the welfare state and increased taxes, tips the country into recession.

Conclusion

Over the longer term, no one can say which vote will lead to the most successful result. It is too big a decision with too many outcomes. We believe the vote will be much closer than the bookmakers would have people believe and the result is likely to come down to turnout. Those who will vote no matter what are more likely to be pro-leave, whereas the remain voters tend to be younger and more apathetic.

We continue to live in interesting times.