Brexit – risks and opportunities for your portfolio
Brexit was a big shock to many investors. There’s been a ‘sledgehammer’ response from the Bank of England. So what can you learn from the risks and opportunities around Brexit?
The Bank of England cut interest rates for the first time in over seven years by 0.25bp from a previous record low of 0.5pc. A £170bn package of additional measures designed to stimulate the economy was also announced given the newly “slashed” growth forecasts. Growth in 2017 is now forecast at a mere 0.8pc, down from a previous forecast of 2.3pc in May.
So what’s been happening in the markets post Brexit?
- Low volatility or low beta stocks have won the day across markets in a risk off reaction. More traditional non- cyclical stocks, such as consumer staples, utilities and healthcare have outperformed financials up to the end of the second quarter. (There has been a significant reversal in July. With the strength of the short-term rally and reduction in volatility, there have been opportunities to increase downside protection in multi-asset portfolios).
- Brexit has driven currency volatility, most notably the Japanese yen strengthened almost 9% and the British pound depreciated around 7% against the US dollar over the second quarter.
- In the UK small caps and mid-caps underperformed large caps by 9.8% and 6.9% respectively due to the higher domestic revenue exposure of smaller companies.
So what does all of this mean for your portfolio?
1. Re-appraise your holdings in light of new circumstances, that is, lower valuations. At Russell Investments we recently conducted a snapshot survey of 12 Value managers for their perspectives on Brexit and value stocks e.g. financials going forward. In short their views were that the sell-off had been excessive:
- The reaction to Brexit and the market impact on valuations of financials was viewed as excessive by the Value managers surveyed.
- The risk-reward trade-off had improved (stating the obvious!), especially for those firms with little direct exposure to the UK. Few solvency and systemic risks now exist due to de-risking and deleveraging since the Global Financial Crisis.
- In terms of actions taken already or likely to be taken, the same managers have or are looking into buying /adding higher quality UK / European financials.
- For European Financials, credit risk had gone up in the near term given a weaker macroeconomic outlook, but the overall view remained that this was modest compared to previous crises.
- Interest rate sensitivity remained high. Expectations for interest rate hikes had been pushed further out.
- Risks of contagion from Brexit can be political and/or economic, for example:
i. Political contagion: Italy, Catalunya, Spain, Scotland etc.
ii. Economic contagion: drag from reduced or impaired trade with UK (Germany, autos, luxury goods, construction etc.)
2. In this current low return environment this is an opportunity for your portfolio to benefit from market volatility. The dynamic management of asset class and investment exposures will be critical to generating returns in the foreseeable future. You should look carefully at the upside versus the downside. This is why at Russell Investments, we unhedged part of our sterling exposure back into USD for our Multi-Asset Growth Strategy (MAGS) ahead of the vote and took profits shortly afterwards, once sterling had fallen.
3. Diversification across asset classes, strategies and best of breed managers is vital. You should measure correlations on an ongoing basis to ensure diversity is maintained to lower overall portfolio risks.
4. Managing risk within your portfolio is key now more than ever before. Avoid drawdowns – a 50% fall in value requires a 100% return to recover losses. The destructive nature of drawdowns is well documented.
You can’t avoid all the risks in your portfolio. However, by taking the approach outlined above – dynamic allocation, downside protection, effective diversification and using best of breed managers across all strategies you mitigate the risks within your portfolio whilst grasping opportunities as they arise.