DON’T OVERLOOK SMALL CAPS
The FTSE 100 might have swiftly bounced back, but its composition is largely blue chip companies and arguably therefore, not the best barometer for UK plc. It is lower down the cap scale where UK companies find themselves at the sharp end of the Brexit fallout.
However, Gervais Williams, managing director and manager of Miton’s UK Multi Cap Income fund, fears investors are punishing all UK small caps without considering valuations of individual stocks or growth prospects.
He says: “It appears that markets are pricing in a recession for the UK and there has been some indiscriminate selling across sectors and companies which are deemed most vulnerable to a downturn. At present the market is not really differentiating between the valuation of individual small cap companies because most are assumed to be domestic earners.”
He believes active fund managers can find attractive opportunities during these periods, but markets will need more political certainty both domestically and with regard to Brexit before they stabilise. “We expect that this may take the next three to six months to filter through,” he adds.
ON SHAKY GROUND
One of the sectors hardest hit by Brexit was UK commercial property and a number of large asset managers suspended trading on their real estate funds as investors rushed to exit the asset class.
While the majority of these were retail funds, the suspensions raise serious questions around liquidity in open-ended funds investing in long-term property assets, as Keenan Vyas, director in the Real Estate Advisory Group at financial advisory firm Duff & Phelps points out.
“For retail funds in particular this presents a challenge as there is an expectation that investors can redeem at all times, as compared to certain institutional funds which can include lock-up periods,” he says. “When this occurs there will be a need on the part of funds to balance managing liquidity and honouring the activities of investors.”
But as long-term investors, pension funds should, in theory, be able to take advantage of the associated illiquidity premium. According to Buck Consultants CIO Simon Hill, a property market correction could favour some investors.
“If we see significant downward adjustments, there may well be opportunities to up their allocation to property,” he says, “but we won’t know until valuations come through.”
BREXIT: A LOCALISED ISSUE?
For Mercer Investments head of asset allocation Rupert Watson, the UK leaving the EU is not a systemic event as it is unlikely to lead to major banking problems in the UK or elsewhere. More damaging than Brexit, he claims, would be if a country left the eurozone, which could potentially be as serious as 2008’s banking crisis.
He explains: “[Brexit] is localised in the sense that if the UK grows slowly in the next few years and gets a deal, good or bad, that will have implications for UK gilts and currency, but it probably doesn’t have implications for US equities, US bond yields or emerging markets. However, if a eurozone country was to leave the EU, that would be massively significant for the whole global economy and would be of an order of magnitude more serious.”
Watson’s message to investors is to diversify their portfolios and stress-test them against certain scenarios.
“If the eurozone gets much worse, are clients taking too much risk or not enough risk?” he asks. “Think, for example, about what happens if Le Pen [Marine] wins the French general election.”
But Buck’s Hill believes in the longer term the departure of the UK from the EU is actually a bigger problem for the EU in economic terms.
“[A country leaving the eurozone] would be a very sharp market event in the short term, but in terms of economic changes, [Brexit] has a bigger impact globally, but it will take some years for that to appear.”
According to PAAMCO managing director Alper Ince, a bigger short-term issue for Europe, separate from Brexit, is the fact Italian banks are struggling to deal with bad debt and loans that are unlikely to be fully repaid.
“People are worried about Italian banks,” says Ince. “The can has been kicked and we are getting close to the day of reckoning. They are trading at 0.3/0.4x book value and that is very low.”
He adds savvy investors, such as some hedge funds, have made money in these distressed times, but those people were probably carrying low invested and tightlyhedged exposures on the back of worries over the outcome of the referendum.
