Introduction
On 23 June 2016 Britain went to the polls in a referendum to determine whether the population wished to remain within the European Union (EU) or to exit. Initial polls had indicated that they would remain within the EU, but the Exit Camp steadily gained momentum such that markets were pricing in an exit a week before the vote. This momentum, however, changed in the week leading up to the vote with markets indicating that the Remain Camp would triumph.
Ultimately Britain voted to leave the EU in a tightly contested referendum that was highly polarised. The initial market reaction has been widespread equity market weakness, weakening GBP versus most currencies (ZAR included) and USD strength versus most currencies – a typical risk off trade.
What Now?
As this result is pretty much unprecedented it is quite difficult to forecast what the impact will be. Initially we can expect the following to occur:
- Increased market volatility (not necessarily all downside)
- More government intervention in markets (easy policy for longer)
The longer term impact is more difficult to determine. The referendum ultimately puts pressure on the British government to start negotiating their exit, with the outcome impossible to determine as no country has ever negotiated their exit from the EU. What we could see, however, is other EU countries also going down this route, which would be destabilising for the EU. There is much water to flow under the bridge before there is more clarity.
How are we Positioned?
Clients rightly want to know how our Funds are positioned and what the impact of the vote will have on their investments. Some general pointers are:
- We are heavily underweight local equity, not because of a possible Brexit vote, but because local markets have been trading at record high valuations (i.e. very expensive). This position will cushion our Funds relative to their long term Strategic Asset Allocation (SAA), but this will nonetheless have a negative impact on performance.
- We are heavily overweight global assets (particularly global high quality equity). The ZAR weakening against all currencies (bar the GBP) will be positive for performance. This will, unfortunately, be negated somewhat by the market weakness in the underlying global assets.
- Overweight local property with a skew to high yielding companies. This position has hurt our Funds over the past 12 months especially as ZAR weakness and slow local growth have impacted negatively on these counters. We expect that these locally focused yield plays will be less impacted by the GBP (and London property price) weakness than those local property companies with lower yielding British exposure.
- Our underweight position in local bonds has benefited our Funds as the currency weakness has resulted in higher bond yields (i.e. capital losses)
- The small position in the New Gold ETF has shown its worth in times of uncertainty and should continue to provide our Funds with some insurance while there is stress in the market.
The key pointer, which can be gleaned from how we are positioned, is that our Funds are highly diversified. When times are good the benefits of diversification aren’t always apparent, but in times of turmoil the benefits of a properly diversified Fund should become clear. Furthermore, the active managers within our Funds will be assessing how the possible exit of Britain from the EU will impact their portfolios and will adjust accordingly.
At Seed, we won’t make any knee jerk reactions. We will wait for the dust to settle a bit before determining how this decision will impact long term market drivers. Should markets overreact in the short term we may look to take advantage in our Funds. We continue to believe that our Funds will deliver on their long term mandates, but investors should expect higher volatility over the short to medium term.
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