27 Oct 2016
Like the majority of the market the Governed Range was positioned for a “remain” vote. Instead sterling weakened, bonds yields fell to historic lows, equities went up with overseas outperforming UK, and a number of high profile property funds suspended trading.
Keeping track of the cumulative effect of Brexit so far is not easy. To help you make sense of it all we’ve pulled together a summary of the key impacts on performance and how the portfolios are positioned now.
Impact on performance
Performance of the portfolios to the end of June relative to the peer group was strong however the impact of the vote led to some short term underperformance against the strategic benchmarks.
While asset allocation and stock selection were both negatively impacted by market reaction to the vote most of the shortfall was due to large valuation timing differences which reversed in July. The three key detractors from performance were
The FTSE 350 Index rose by 2% between noon and the close on the 30th of June after a speech by the Bank of England Governor, Mark Carney. The RLP funds are valued at midday compared to an end of day valuation point for the benchmarks which meant this rise wasn’t captured in the quarter end figures. This effect subsequently reversed, generating a positive contribution to relative performance figures over periods to the end of July.
Within the GPs the RLP equity and bonds funds underperformed due to a combination of above benchmark exposure to UK mid cap stocks, short duration positioning within bond funds reflecting RLAM’s long held view that bond yields are too low, and a preference for less liquid names within fixed income as uncertainty after the vote led to a sudden drop in interest rate expectations and a widening in spreads. Since the vote we have benefited from a considerable
rebound in UK midcap. Credit has also rebounded strongly, we think the default risk is overstated and expect credit to outperform gilts going forward.
We were underweight bonds on the basis that we expected a steady global economic recovery accompanied by interest rate rises in the US and in the UK. Instead bonds went up on the vote and again when the Bank announced a base rate cut and other easing measures.
How we have responded to BREXIT
We continue to expect a modest upturn in global economic growth with limited impact from the Brexit vote. The impact on the UK economy is more significant and we see a technical recession, the BOE has already eased policy and we expect a further base rate reduction. Inflation should increase from the current low levels, as the impact of a lower oil price fades. Within the Governed Range, we are positioned as follows:
1) We reduced our underweight in bonds in July, ahead of what we expected to be aggressive BoE action at the August Monetary Policy Committee meeting. Now yields have fallen to what we see as unsustainable levels over the long run, we are starting to sell again. BoE quantitative easing has massively distorted the bond market with the yield curve suggesting one year rates will remain at or below 1% for the next twenty years.
While technical factors or weak economic growth could result in even lower yields in the near term, we expect yields to rise from current historically low levels.
2) We remain overweight equities and are adding at the margin. Positive US and global growth with loose policy provide a positive backdrop even if markets are overbought in the short run.
Regionally, we cut European equities to underweight, raising the more defensive US market. We are neutral UK equities on the basis that while there is downside pressure on the domestic economy, loose policy and a weak pound are positive for stock prices. We have moved Asian/emerging markets more overweight as they stand to benefit from looser US monetary policy and ongoing growth in China.
3) We remain neutral on property but a temporary downturn may end up providing a buying opportunity.
While the full implications of Brexit are not yet clear, market shifts provide opportunities for us to adjust positioning. Diversification will be important during bouts of volatility and the broad spread of exposures provided by the new Governed Portfolio benchmarks should offer some stability in times of turbulence.