CC-BY-SA-2.0, FlickrPhoto: D Chris. Careful With The Brexit: Not To Confuse The Local Economy And Politics With Markets
The United Kingdom’s decision to leave the European Union has begun to reverberate around the world.
Prime Minister Cameron has announced he will resign in October, around the time of the next Conservative Party annual conference. Only after a new prime minister is in place will the UK trigger Article 50 of the Lisbon Treaty and start the two-year process of negotiating its exit from the E U.
From a credit perspective, the ratings agencies have made it known that the UK’s sovereign credit rating will be downgraded as a result of the decision to leave the European Union. Standard and Poor’s called the AAA credit rating ‘no longer tenable under the circumstances’. Moody’s called Brexit a credit negative for the UK and for other issuers in the country, citing a prolonged period of policy uncertainty that will likely dent investment flows and confidence. On an absolute basis, UK gilt yields may fall in the near term, but spreads could widen.
Central banks have made it clear that they stand ready to provide liquidity to financial institutions — and in some cases intervene in currency markets — amid volatile market conditions. Expect central banks to work together to suppress volatility. A rate cut by the Bank of England in July is increasingly likely, while the US Federal Reserve, as a result of the vote, is unlikely to hike short-term rates for the balance of the year.
Currency markets have borne the brunt of today’s volatility, with the pound falling by a record 11% against the dollar in the wake of the vote before stabilizing. Equity markets were hit hard at the open of trading on 24 June, with the FTSE 100 Index falling nearly 9%, but those losses moderated significantly as the session wore on. The moves have been relatively sensible, with the sectors most at risk in the short term — financial services and cyclicals — bearing the brunt of the pressure thus far. Ten-year UK gilts fell to a record 1% before stabilizing near 1.10% toward Friday’s close, while the 10-year US Treasury note tested record low yields, near 1.40%, this morning before rebounding to 1.57%.
This sort of environment can create opportunities for investors. We are long term in our focus, and we’re very careful not to confuse the local economy and politics with markets. We invest in international and global businesses, and stock prices act as a discounting mechanism. Some of the impacts of the Brexit vote may already be reflected in prices. Against this more volatile backdrop, long-term inefficiencies may emerge. There are great businesses that have been hit hard in the short term, and there are others where risks have increased substantially. This is the type of environment where long-term active managers would be expected to add value. After all, volatility should be our friend over the long term.
In fixed income, we continue to look for opportunities where valuations have become dislocated. We’re going through our names and sector exposures, deciding where we want to add or reduce risk. We’re not rushing, as we’re mindful of challenges around liquidity in the near term. We’re largely taking a wait-and-see approach, awaiting improved liquidity. We have already identified specific credits and sectors, so we can move quickly when the environment is conducive to adjusting portfolios appropriately.
Politically, it’s not over
As Michael Gove said during the Brexit campaign, many ‘have had enough of experts’. That sentiment is being felt far beyond the UK’s shores, notably within Europe and the United States. While the Brexit vote has brought a slight bit of clarity to the UK’s future relationship with the EU, it opens the door for a potential domino effect across Europe as populist movements gather strength. Investors wonder which countries will be next in the queue for an EU referendum of their own.
To sum up, it looks as though the UK’s decision to leave the EU could be the beginning of a large, protracted process in which dissatisfaction with the effects of three decades of globalisation is being expressed in ever more impactful ways. It bears watching to see if the trend accelerates, and what lasting impacts, if any, these political forces will have on companies around the world. Geopolitical conditions are ever shifting, but great businesses always seem to find a way to adapt and prosper over time. We suspect they will be able to weather this storm.
Pilar Gomez-Bravo, Fixed Income Portfolio Manager, and Ben Kottler, Institutional Equity Portfolio Manager – UK.
CC-BY-SA-2.0, FlickrPhoto: Iain Cunningham, Portfolio Manager in its established multi-asset team. Investec Asset Management Appointed Iain Cunningham to its Multi-Asset Team
Investec Asset Management has announced the appointment of Iain Cunningham as a Portfolio Manager in its established multi-asset team. Iain brings an extensive track record dedicated to multi-asset investment, most recently at Schroder Investment Management.
Iain Cunningham will join the firm’s multi-asset investment capability, reporting to Michael Spinks, co-Head of Multi-Asset Growth at Investec Asset Management. The range of solutions managed by the 31-strong team includes total return and relative return growth strategies, as well as defensive income.
Michael Spinks, co-Head of Multi-Asset Growth, commented: “We are excited about Iain joining the team given the asset allocation skills and experience that he brings with him. In addition to portfolio management responsibilities, Iain will help to develop Investec’s multi-asset capabilities globally, with a specific focus on our long-standing relative return growth strategies.”
Iain Cunningham joins from Schroder Investment Management where he spent nine years in investment management roles within the multi-manager and multi-asset investment teams – he co-managed the Schroder ISF Global Multi-Asset Income Fund and was co-manager of the Global Multi-Asset Allocation Fund. Additionally, he managed Global Tactical Asset Allocation mandates; was instrumental in developing Schroders’ Multi-Asset Income franchise; and led currency research for the multi-asset team.
“With today’s low growth environment and uncertain economic backdrop, clients are increasingly looking to target investment outcomes based on risk and return”, said Spinks. “Having managed multi-asset portfolios for over 25 years, our core investment capabilities are firmly established, and Iain will play a key role in helping us to continue to seek strong results for our clients.”
CC-BY-SA-2.0, FlickrPhoto: Roman Lashkin
. Why Investors Overreact to Market Corrections?
The short answer for Bernie Scozzafava, Diversified Fixed Income Portfolio Manager, and Dan Codreanu, Senior Diversified Fixed Income Quantitative Analyst at Eaton Vance, is that it’s human nature, irrational though it may be in many cases:
Loss aversion: Behavioral finance tells us that fear trumps greed. In other words, most investors dread losses more than they desire gains.
Recency bias: Recent events trigger hasty decisions, even when such events contradict longer-term trends or investment objectives.
Overreaction bias: Most investors place too much emphasis on negative, sensational news headlines, leading to indiscriminate selling.
Herd behavior: Investors take an “everyone is selling” mentality and follow suit because they fear being the last one to sell.
According to Eaton Vance experts, these all-too human tendencies were exacerbated by the 2008 credit crisis, which left many investors permanently scarred. This debacle, caused by massive losses on subprime loans, sparked the worst market collapse in more than 75 years. Although nearly eight years have passed since then, the carnage still remains fresh in investors’ minds, with many fearing that the next recession and market downturn will be just as bad.
“More often than not, such fears are unfounded. For example, there is growing concern (and press coverage) these days that bank loans to the energy sector could pose a serious threat to the economy and financial system – even though banks generally do not have excessive E&P exposure, are better capitalized and adhere to stricter counterparty risk measures than they did prior to the 2008 crisis”, point out Scozzafava and Codreanu.
Investors with long time horizons are best positioned to tolerate market volatility and earn attractive returns over time, but instead, many behave irrationally and sell during corrections to limit their short-term losses.
“Market volatility and corrections are many investors’ biggest fear. However, we believe a bigger fear should be missing out on the market recoveries that typically follow the corrections. Our research shows that when disciplined, data-driven investing gives way to biased, emotion-driven investing, portfolio performance suffers”, conclude.
Hamish Forsyth, CEO at Capital Group for Europe. . "We Look Forward to A World Where It Is Clear The Investor Is Paying for Advice and It Is Not Being Bundled into Our Investment Management Fee"
The heart of what Capital Group has done for 85 years in the US is mutual fund distribution through financial advisors to individual investors and they want to do that in Europe and Asia as well. Hamish Forsyth, Capital Group’s CEO for Europe, explains in this interview with Funds Society his plans for the continent. Always, with a long-term view and being aware of the regulatory and political challenges: “If Brexit was to materialize, with modifications, the management company in Luxembourg could take on the role currently played by London”, he says. But he believes there are opportunities in Europe and Spain, specially for companies stable and conservative as Capital Group.
How do you assess the development of Capital Group in Europe in the last years?
We have been in Europe since 1962 and we have built, particularly through the 1990’s, a meaningful size institutional business; historically our focus has stayed on the institutional market. Since the financial crisis we have been working hard on a plan to develop a mutual fund distribution business. The heart of what Capital Group has done for 85 years in the US is mutual fund distribution through financial advisors to individual investors and we want to do that in Europe and Asia as well. We are physically present now in support to that mutual fund distribution business in London, Zurich, Geneva, Frankfurt, Luxembourg, Milan, Madrid, Hong Kong, Singapore, New York and Miami.
In which markets will Capital Group focus on in 2016 and which are the favorite ones for boosting its business?
This is like with my children, I have no favorite one.
The uncertainty because of elections in Europe and geopolitical risks (Brexit, elections in Spain, rise of populism in Austria): How could it affect to your business development strategy in Europe?
Let´s distinguish between portfolio impact and business planning impact. So, there are lots of things that could affect stock markets, bond prices, and I´m not worried about that so much, I am not a portfolio manager; I leave that to the portfolio managers. For me, as CEO, my focus remains on the factors that could impact our business development strategy. Obviously, Brexit is one of them. We have a strategy throughout the EU that it is based on our UK company and our ability to passport our services from the UK. And if the UK leaves, we presumably will have to find another way of doing that. We have a small management company in Luxembourg today that takes care about our funds (domiciled in Luxembourg) and if Brexit was to materialize, with modifications, that management company could take on the role currently played by London.
Political uncertainty mostly is not affecting our business planning but regulatory uncertainty certainly does. We are in an era of significant regulatory changes and we spend a lot of time thinking about that.
In the case of Spain-Iberia: How are your goals working since the office was opened?
We came to Spain in 2014 to stay. Our goals and measurements of success therefore go beyond AUM and sales objectives. Our initial objective was twofold: firstly, to get to know the local market and distributors needs better and secondly, for us to start introducing CG investment process and capabilities. We trust this approach will help us building a solid, balanced long term business in Spain which is our ultimate goal. 2015 was our first full year in Spain and we feel we have progressed well in our efforts to introduce CG in the local market.
How do you see the positioning of international asset managers in Spain? Are there opportunities?
We had a faster than expected progress last year, which was our first full year with the team in Madrid. Since then, we have also hired a dedicated marketing manager for Spain, so the team has grown. Like everybody this year has been harder; it has been a hard year for mutual fund sales across the board in Europe and our challenge continues to be to find really first class organisations we can do long term business with.
Another important thing to stress, is that now Capital Group is known for the right reasons. We are not only just one of the biggest asset managers in the world. Apart from that, we are very different compared to other big asset managers. In this sense, the feedback we are receiving from clients is very good. We received a very warm welcome from Spanish investors. We trust our investment philosophy and our conservative and long term approach fits well with Spanish investors.
We could say we are a slightly old fashioned, rather conservative asset manager. What we have seen over our 85 years is that people who come to know us well appreciate us greatly. We are not a firm which is necessarily going to dazzle you with star products, a star manager or an outstanding short term investment result because this is not what we are looking for. What we are looking for is long term sustainability of good investment results. This is something that people have to come to learn about us and part of Mario and Álvaro’s jobs in the ground. In this context, and given our way of managing money, it’s important that we present the firm and our investment process before we sell our products.
In the last years, many asset managers have entered Spain; do you think that the Spanish market is crowded now? Where is the market niche for Capital Group?
Yes, we think it´s a crowded market. In the short term, inflows in the Spanish market have attracted a lot of new asset managers chasing short term inflows. Our view is more long term oriented. We think there is a long term opportunity for asset managers in the Spanish market and, in particular, for stable, conservative international asset managers like us.
How many products are currently registered in Spain and which are your latest news? And which products will you bring in the near future?
All of our Luxembourg funds, which are about 20 products now, are registered for distribution in Spain. Spain is an important market for us. We are on the process at the moment of bringing to Europe a number of our long standing American mutual funds. This is the heart of our firm, the family funds called American Funds. In October last year we brought a global equity portfolio, the New Perspective Fund launched in 1964. This month we are bringing our oldest mutual fund, The Investment Company of America, a US equity fund with an 82 year track record which launched in 1934. And later this year we are bringing New World Fund, an all country fund looking to get exposure to emerging markets through multinational companies.
We will continue to bring American funds to Europe and they can be an important manifestation of what we were saying earlier about the long term sustainable nature of what we aim to do.
Are you planning to expand your Iberian team in the mid-short term?
As we mentioned early, we have hired recently a new country marketing manager, Teresa García. One of the goals of our local presence is to provide the best service and support we can to our clients and distributors. That´s what drives the size of the team and currently we are happy with the current size of the team.
Many people argue that the environment will become more complicated for asset managers in the forthcoming future, due to the margin compression, the increase in costs, new regulation, and competition from passive products… Which are in your opinion the most important challenges for the AM industry, especially for Europe, in the next years?
The first thing I would say is that I remain rather positive. Regulatory change has often been very helpful for asset managers, and for us as a firm; and the creation of the single European market for mutual funds, the UCITS directive has given international players like us the ability to distribute one fund cross border in many countries, this is an incredible privilege and one we have taken advantage of.
Regulatory changes have resulted on margin compression and lower fees. As a firm, we believe very strongly in the importance of good advice. We think investors have better financial outcomes when they have worked with a good financial advisor but as I said, in a way, we look forward to a world where it is clear the investor is paying for that advice and it is not being bundled into our investment management fee. A world eventually where it is clear who is doing what for what fee is positive for us as a firm.
The most important challenge for us as an active asset manager has to be results. Linking back with something I´ve said earlier, if fees come down, in the end, it makes it easier for us to do a good job of producing investment results after fees.
Some American and Canadian asset managers are coming to Europe and expanding their product ranges with UCITS products, is this a long-lasting trend? Why?
I think it probably is. If you want to expand as an asset manager and you’re based outside the EU, I think expanding in the EU is always going to be an obvious move because of what we said earlier about the size of the client field, and because of the ability to distribute one set of funds across multiple markets in the EU and beyond. The UCITS magnet as a place for people to start is pretty good. We are not part of the UCITS magnet. We arrived to Europe in 1962 and launched our first fund in Luxembourg in 1969, so our commitment to cross boarder distribution of mutual funds in Europe predates UCITS by a couple of decades. However I think this is an explanation for why so many fund managers are arriving now.
You recently hired a new sales person to cover NRC Markets. How are you positioning yourselves?
Regarding NRC regions, indeed we now have a team of two front line sales people, one based in New York and another based in Miami, covering the main NRC territories in the USA. So, we feel now we are one step closer to the market.
CC-BY-SA-2.0, FlickrPhoto: David Dennis. MSCI Delays Inclusion of China A-Shares in Index
Late on 14 June, MSCI, a provider of global equity indexes, announced that it would delay including China A-shares in the MSCI Emerging Markets Index. This was the third year running in which MSCI has denied China’s onshore equity markets entry into the index.
MSCI acknowledged that China had made significant progress towards addressing its previously cited concerns: issues regarding beneficial ownership, regulations on trading suspension, and the allocation and capital mobility restrictions for qualified foreign institutional investor (QFII) quotas. However, the index provider still believed that the 20% monthly repatriation limit remained a significant hurdle for investors that may be faced with redemptions. The firm also stated that its concerns about local exchanges’ pre-approval restrictions on launching nancial products remained unaddressed.
Both international investors and local regulators have been impatient for the MSCI nod, which would be a signi cant step towards the internationalisation of China’s largely closed capital markets. Despite many being disappointed by this decision, the press release from MSCI is positive. It said that it did “not rule out a potential off-cycle announcement should further significant positive developments occur ahead of June 2017.” We believe that the Chinese authorities will continue to work with MSCI to achieve inclusion in the MSCI Emerging Markets Index, as this is a key area of focus for the government. It is less a case of if A-shares become included, but when.
Ultimately, we believe that China is too big to remain out of MSCI’s flagship emerging markets index, to which an estimated US$1.5 trillion is benchmarked. The People’s Republic has the world’s second largest economy (almost US$11 trillion) and equity market (total market capitalisation of approximately US$7 trillion) and cannot be ignored.
We believe that the A-share market is changing rapidly and has an abundance of investment opportunities, with over 4,000 companies listed. As China rebalances its economy, and services grow faster than heavy industry, the equity market increasingly represents a new consumer-facing Chinese economy. We believe there are manifold opportunities in sectors and services such as food producers, automobiles, appliance manufactures, leisure and gaming companies, pharmaceutical and healthcare. And not forgetting some of the world’s most innovative internet companies.
Although MSCI’s decision is not necessarily the one we were expecting, we continue to build and invest in the 4Factor EquityTM China team of highly capable and talented investment professionals focusing on the domestic A-share market. We have been investing in the country for almost two decades and have experience and expertise to enable us to identify a large number of good-quality companies with good growth at attractive valuations. Now, more than ever, we are sticking with our belief that early moving investors are likely to reap long-term rewards.
Greg Kuhnert is a portfolio manager and financials sector specialist in the 4Factor Global Equity team at Investec Asset Management.
CC-BY-SA-2.0, FlickrKen Nicholson, courtesy photo. Mirabaud AM: “Good Small Caps Can Provide Resiliency And Durablility Even In Difficult Times”
Ken Nicholson, PM for the European Small Caps Fund at Mirabaud Asset Management talks about the performance European small caps have had this year. “The market value of the companies in our portfolio is usually between €500m and €4bn. We find opportunities not just classic growth stories but also some restructuring and value ideas,” he points out in this interview.
What is the fund’s investment philosophy? To invest in 40-50 European small and mid-sized companies that will provide a strong investor return. The market value is usually between €500m and €4bn.
How has been the performance of European small caps this year? On average, the performance has been average but the better names would have provided a strong return. So your returns depends on good stockpicking. Our performance has been as well average, as the major trend in the market is.
How can the slow growth and deflation in Europe affect European small caps? Of course it is better to have a good economic development as this provides a strong tail-wind for all businesses. But our strong view is that good small companies can provide resilient and durable even in more difficult times.
Do small-caps look attractive versus large-caps? Not especially on valuation but forecasts are for a little higher growth for small companies. However it is important to be very careful in picking only the best stocks. Smaller companies often operate under less market scrutiny than their larger rivals and have lower liquidity.
Are riskier assets than large-caps? Smaller companies are usually considered more risky but this is the mentality of an asset allocator. There are many stock specific risks in every case. Just because the Banks were big and oil companies too didn’t save them from disastrous performance. You can find risky small caps but you also can find very safe and stable ones. Our job is simple …to pick the good small companies!
What are the reasons why investors should consider investing in the European small and mid strategy? In a low-growth world where there are few other good investment opportunities, we still find many great small cap names that offer good return potential.
Where are you finding opportunities? We find good names in most sectors and in most countries. Not just classic growth stories but also some restructuring and value ideas. The economic environment is not especially supportive but then it has also been a lot worse!
What do you expect for the next months? We seem to be in a low growth environment with the remnants of the financial crisis still not finally eradicated. Political risks are uppermost in investor minds, of course in Spain and also with the Brexit vote which could impact on the whole of Europe, not just the UK. Investor uncertainty is intense and this leads to market volatility. All this can provide opportunities to time a good entry point for investing in good small and mid cap companies.
CC-BY-SA-2.0, FlickrPhoto: Reserve Bank of India Governor Raghuram Rajan. University of Chicago. "Rexit" in Context
Over the weekend, the big news out of India was that Reserve Bank of India Governor Raghuram Rajan would not be seeking an extension to his term, which will expire in September. He said that he would be returning to his “ultimate home in the realm of ideas,” at the University of Chicago. Rajan also said that he was open to seeing current developments through, but that upon due reflection and consultation with the government, has decided not to seek an extension. While change is always uncomfortable and creates uncertainty at times, our reaction to this event should consider the broader context.
Over the past three years, Rajan has been an influential and skilled central bank governor. He can be credited with enacting a few key policies, including the adoption of inflation targeting using the consumer price index (CPI), instead of the wholesale price index (WPI). CPI holds a larger component of food, affecting the average citizen. Hence, to have accommodative monetary policies, the government has to make structural improvements to lower food inflation—which has been a historical pain-point for everybody.
Rajan also pushed banks to recognize non-performing assets in the banking system. This cleansing of the banking system along with India’s newly created Bankruptcy Law, should serve the country well over future credit cycles. Rajan, along with the government, also announced the formation of the new Monetary Policy Committee (MPC) into a law. The formation of the MPC borrows best practices from other countries and further institutionalizes the mechanism for setting interest rates. Putting into motion a few of these changes, which perhaps will be part of Rajan’s legacy, are already underway and should produce results even after his departure.
Rajan could have stayed to see these changes through by extending his term, but there are a number of factors outside his control and domain. During his tenure, commodity prices collapsed and India’s trade/current account benefited and helped the currency. That tailwind is less likely to exist going forward. Therefore, the next two years could potentially pose a more difficult environment than the last three years.
Rajan will wrap up as the 23rd RBI governor since 1935. The average tenure of an RBI governor is only three and a half years, unlike longer tenures in U.S. Even with a term extension, Rajan would have served only for another two years. RBI as an institution, among others including the Supreme Court, has always been a pillar of strength in India. Previous RBI governors have also been reputed policy makers.
There are a number of qualified individuals already being considered to fill the role. More broadly, terming Rajan’s departure as “Rexit” sensationalizes the event. Such heavy “personalization” of the role of governor of an important institution also plays well to the media. However, given the RBIs strength as an institution over many decades, I believe even though the direct style of communication as embodied by Rajan may change, the substance of RBI’s policies will endure.
Rahul Gupta is a Portfolio Manager at Matthews Asia and co-manages the firm’s Pacific Tiger Strategy.
CC-BY-SA-2.0, FlickrPhoto: Danielle Bauer. Which Afores Make the Best Investments?
For pension funds such as Afores, although short-term yields are relevant, considering that the funds they managed will be used for the retirement of workers at 65 years of age, the results should be analyzed on the long-term.
According to CONSAR the annualized nominal net returns between January 2009 and March 2016 shows: Sura, Banamex and Profuturo as the three best performing Afores with 10.5, 10.1 and 10.1% returns respectively. (Report to Congress 1st quarter of 2016 Page 46).
The weight of different asset classes in their portfolios average: 74% in fixed income (53% in government bonds, 20% in corporates and 1% in international debt); 20% in equities (13% in international equities and 7% in domestic equities); while 6% of AUM are invested in structured instruments and mexican REITS or Fibras.
In the report, CONSAR presents the performance attribution by asset class for each one of the 11 Afores. The analysis (page 48) shows that 3/5 of the performance comes from debt instruments; 20% equities and the difference by others asset class incluiding Fibras and structured (where are included CKD’s). Fibras and CKD´s, only have contributed to portfolio performance 0.1% of 9.5% average return. It is noteworthy that the first CKD emerged in 2008 and the first Fibra was born in 2011 so the contribution do not reflect the maturity period requiring investments in CKDs and in the case of the Fibras considered a lower time investment since inception.
Reviewing the performance attribution by asset class for each Afore it can be seen that the most profitable Afores lead returns in two or more asset classes. Sura for example excels in Bonds, international equities, as well as structured and Fibras relative to the others Afores. Afore Banamex is distinguished by good results in the inflation linked bonds (Udibonos and CBIC) and international instruments. In the case of Profuturo, inflation linked bonds, corporates and local equities are where the afore leads.
Looking at results by asset class, Invercap generates higher returns in bonds which allows for it to place 4th place in returns. Azteca is the second most profitable in this asset class, however this result is not good enough to place it at the top. This Afore also excels in domestic equities.
XXI-Banorte also is among the Afores with better results in local bonds and corporates papers, however these results are not enough and the returns of this Afore are below the average performance of the 11 Afores (9th place).
Looking at investments in inflation linked bonds, the Afores that have obtained the best results in these instruments are: Profuturo, Banamex, Pensionissste and Principal. Pensionissste has also good investments in corporate debt , which allows it to stand in fifth place in the returns table while Afore Principal also excels in international equities ttaking the 7th place.
For the asset class of structured instruments and Fibras, the Afores with the highest returns are Inbursa and Sura contributing 0.4 and 0.3% compared to an average performance in this asset class of 0.1%.
Overall each one of the 11 Afores have at least one asset class in which they stand out for their results, however, if the weight is not important in contributing to performance, its advantage is not enough to take them to the top performance on a stage of just over seven years (January 2009-March 2016). Not only does the manager have to be good in asset classes that have greater weight in the portfolio compared to competitors, but also they need not be so bad in the others asset class to offer attractive returns.
CC-BY-SA-2.0, FlickrPhoto: Camilo Rueda López. Countdown To Brexit: What You Need To Know
Tomorrow, Britain will vote on whether or not to leave the European Union. Given the deep economic ties between Britain and the EU, “Brexit” would have implications across the global economy. “Before we understand the implications, it’s important to establish that Britain is an open economy actively involved in the global economy and heavily intertwined with the EU. Here’s what that looks like”, explains Colin Moore, Global Chief Investment Officer at Columbia Threadneedle in the firm´s Global Perspectives Blog.
Britain’s EU membership
Britain joined the EU in 1973 and is now one of 28 current member states. Nineteen of these share the euro as a common currency, accounting for around three quarters of EU gross domestic product (GDP). Britain is not part of the common currency and continues to use the British pound. The existence of the British pound with a floating exchange rate has given the Bank of England an array of policy options to manage the shocks to which Britain’s economy is subject.
The sizable impact of Britain’s role in the EU
While we may not be able to measure the precise impact of EU membership on Britain’s economy, it can demonstrate the interconnectedness of Britain and the EU. The following is extracted from the EU membership and Bank of England Report, published October 2015. British pounds have been converted to U.S. dollars based on an estimated exchange rate of 1.42.
Population
505 million people live in the EU, approximately 7% of the world’s population.
Britain is home to 12.5% of the EU’s population, the second most populous EU country.
Economies
EU is the largest economy in the world with GDP worth £11.3 trillion (approximately $16 trillion) in 2014, which is larger than the U.S. ($15 trillion).
Within the EU, Britain is the second largest economy.
The U.K. GDP was worth £1.8 trillion (approximately $2.6 trillion) in 2014, nearly one-sixth of EU output.
Cross-border trade
One-third of all global trade is with the EU, the largest exporter and importer in the world.
The EU is Britain’s biggest trading partner.
The U.K.’s exports and imports are worth 60% of its GDP.
70% of Britain’s largest import and export markets are fellow EU members.
The EU serves as the destination for or source of more than two-fifths of Britain’s cross-border investments.
Britain is one of the top destinations for foreign direct investment (FDI) within the EU and globally.
Two thirds of all global cross-border investment involves the EU.
Foreign investors own £10.6 trillion (approximately $15 trillion) of U.K. assets while U.K. investors own £10.2 trillion (approximately $14 trillion) of foreign assets.
The EU has one of the world’s largest financial service sectors, second only to the U.S.
The EU is home to 14 of the world’s 30 globally systemically important banks (GSIBs) versus eight for the U.S., and accounts for half of all global exports of financial services.
Britain is the largest financial center in the EU, with financial services accounting for 8% of Britain’s national income.
The British financial sector is heavily interconnected with the rest of the EU, with 80 of the 358 banks operating in Britain headquartered elsewhere in Europe.
A long goodbye
Global Chief Investment Officer at Columbia Threadneedle reminds that even if the referendum passes, a decision to leave the EU will not be effective for two years after a formal notice to leave is issued by the British government. The time between vote and exit would be critical to untangle the myriad of interconnections and negotiate new agreements. Agreements on trade, people movement, investment and financial services are important to both Britain and the EU. They are also important to the global economy.
Bottom line
“Overall, it is clear that a post-Brexit world would have its challenges. Only time will tell how the world reacts if Britain decides to leave the EU, but this is a global event not just a British or EU event. Many financial markets are at or above fair value and any disruption to growth would be cause for concern. In the event of market disruption caused by the vote, investors should keep in mind that an exit from the EU is not immediate and the required changes would take years to see through”, concludes Moore.
CC-BY-SA-2.0, FlickrPhoto: Hendrik Dacquin. European Equities Supported By Continued Earnings Recovery
Despite the bumpy start to the year in global equities, Investec has not changed its fundamental view for a recovery in European corporate earnings, and it remains cautiously optimistic about the outlook for European equities.
As Figure 1 indicates, expliains Ken Hsia, portfolio manager at Investec European Equity Fund, European companies have not seen the same recovery in their ROE as their US counterparts. And despite seeing a drop in the ROE of the MSCI Europe in recent months, largely due to declining returns from the resources sector, we believe they should continue to close the gap. “While increased instances of consolidation across some industries has helped to unlock cost synergies, merger & acquisition (M&A) activity in Europe has been slow compared to the US”, points out.
Furthermore, as a net consumer of oil, says, Europe is set to bene t from lower global commodity prices and this tailwind should help to support a gradual recovery in the European economy.
Those are current investment themes in the Investec European Equity Fund:
1. Global winners
Investing in Europe means investing in European expertise and not countries. Europe is home to many world class companies with strong competitive advantages, which we believe give them strength in any global economic environment.
Pernod Ricard SA – As the second largest spirits company in the world, they have strong market positions. This, coupled with the aspirational nature of its product portfolio, has led to strong returns.
2. Exposure to Europe and seeing less competition
Country reforms in recent years have provided a strong basis for stability in the region. We are seeing European exposed companies gaining more market share as consolidation across some industries has helped to unlock cost synergies.
Michelin – Second-largest tyre manufacturer in the world that is undergoing an ef ciency programme to boost returns. Additionally, demand for SUV tyres, which have better margins, is on the increase.
3. Knowing what to avoid
Investec constructs its portfolios from the bottom-up, as such we are able to selectively capture investment opportunities. This adaptable nature also means we are able to avoid challenged industries, enhancing the potential to outperform.
“While our bottom-up portfolio construction process allows us to avoid challenged industries. It also means we monitor good European companies that are becoming cheaper due to current market environments”, concludes Hsia.
