Global shares dropped sharply and reverberations were felt across all financial markets on Friday as investors digested the United Kingdom’s decision to leave the European Union. Here is a quick summary of how your investments were positioned and what the future might hold….
How were the portfolios positioned for Brexit?
The core of each portfolio is made up of long-term holdings designed to achieve a key objective: generate income, mitigate rising living costs (inflation), or grow your capital over time. All portfolios were fully invested to achieve their objectives ahead of Brexit, and the outcome of the vote is unlikely to change that.
That being said, a number of measures were taken in the months leading up to the vote to mitigate against the uncertainty created by a possible negative outcome. Broadly speaking, these were as follows:
In the income category we refocused the Global Income Portfolio on bonds issued by defensive companies in sectors such as consumer staples, healthcare and telecoms. We also increased the Portfolio’s weight toward long-term New Zealand bonds as we believe defensive companies and the New Zealand economy are less likely to be affected by the uncertainty in Europe.
In the inflation category clients hold an exposure to global shares and bonds, in combination with a number of defensively orientated hedge funds (International Standard Asset Management, Universa Investments, Paulson & Co and True Partners) as well as listed property and commodity holdings. While we had reduced all index exposure to the United Kingdom share market and British pound, clients will nevertheless be impacted in the short-term due to the global nature of the sell-off.
Similarly, in the Growth category clients’ portfolios are approximately 7% underweight United Kingdom shares (relative to global share market index) with the only exposure to that market being to those companies individually selected by the active investment managers we employ on clients’ behalf. Again, while exposure to the United Kingdom is modest we expect clients’ investments to broadly track the movements in the global share market in the short-term.
Over the past year we have progressively increased clients’ exposure to large and defensive New Zealand and Australian dividend paying companies. We expect these companies to hold up relatively well in the event of a global sell-off.
Across all portfolios we have very little exposure to foreign currencies, the asset class which has proven most volatile in the lead up and immediate wake of the Brexit decision.
In the Core Growth Portfolio and the Global Multi-Asset Growth Portfolio we recently made a modest (5% – 10%) investment in gold and gold mining companies. Both of these investments rose sharply on Friday, in contrast to the declines in almost every other growth asset class.
What does Brexit mean for clients’ longer term growth investments?
Across all diversified portfolios we manage, our clients’ two largest investment exposures are United States listed companies and New Zealand listed companies. That includes exposure to both the bonds and shares issued by those companies.
Brexit should not have significant consequences for the near term performance of those companies. For the United States, the United Kingdom accounts for only 3% of the combined revenue of all of the companies in the S&P 500 share market index. Similarly, the New Zealand economy should not suffer in the short-term and might even benefit from renewed trade agreements with the United Kingdom in time.
Why are financial markets worried about Brexit?
The economic consequences of Brexit by themselves are unlikely to be severe enough to cause lasting global damage. The problem lies in investors’ tendency to overreact to an unexpected outcome, an affliction that impacts both individual and institutional investors to varying degrees.
A big sell-off in global financial markets can lead to corporate downsizing, delayed expenditure and less consumer spending. These in turn can lead to a real economic slowdown. So, financial sentiment in the days and weeks to come is important.
Brexit might also lead to a series of exits – prime candidates include Scotland, Ireland, France and the various Scandinavian countries. This would create the type of ongoing uncertainty investors do not like and would likely lengthen the time it takes for Europe to recover.
Would a global slowdown be as bad as the Global Financial Crisis in 2007 – 2009?
We think Brexit is more akin to some of the global shocks we have seen over the last five years. Events such as the fear that Greece might exit the European Union, the slump in the price of oil and the volatility caused by the prospect of a sharp drop in Chinese growth. In each case financial markets endured a tumultuous period but recovered relatively quickly and resumed their upward course.
By contrast, the Global Financial Crisis was a global slowdown and a banking crisis combined. Much of the world’s banking sector required recapitalising to avoid failure. It is worth noting that just last week the Federal Reserve, who oversees the United States banking sector, issued pass grades for every major bank in the United States following their annual stress test. Similarly, in Europe and the United Kingdom, the reserve banks have been putting the banking sectors through their paces, to ensure that they are appropriately prepared.
Several Reserve Banks around the world, including in the European Central Bank, United Kingdom and the United States, have said they will monitor events closely. They stand ready to support financial markets with a range of policy tools should negative sentiment begin to weigh on global growth prospects.
What downside mitigation strategies do clients have in place today?
Broadly speaking there are four legs to clients’ downside mitigation.
First, clients hold a diversified range of assets and not just shares. Client portfolios are built up from four investment categories: cash, income, inflation and growth. Depending on each client’s income requirements, risk profile and time horizon, he/she will hold different proportions of each of these investment categories.
Secondly, irrespective of risk profile and time horizon, clients hold a mix of local and international investments so that the long-term returns of their portfolio are not unduly dependent on any one economic region. These events remind us of the risk of concentrating all of one’s assets in one geographic market (and we include New Zealand in that).
Third, NZ Funds utilises a range of global investment specialists, especially in the growth category. These specialist managers typically take a more defensive investment approach and aim to perform better than the broad market index during periods of market stress. In addition, clients’ portfolios contain three managers: International Standard Asset Management, Universa Investments and True Partners which are capable of delivering outsized gains if and when global share markets fall substantially.
Finally, NZ Funds takes an active approach to investment management. As discussed, we have made a number of adjustments to portfolio positioning ahead of Brexit and will continue to monitor clients’ portfolios and market events closely and endeavour to keep you updated on any major changes.
Should you wish to discuss any aspect of your portfolio further please do not hesitate to contact Bill Raynel on 09 4385678 or email us: firstname.lastname@example.org
Michael Lang, CFA
Chief Investment Officer