28 June 2016
Life after Brexit: the views of a Danish global equity income manager
With Jacob de Tusch-Lec, manager of Artemis Global Income
“The world has not ended and business continues, but the EU referendum result has changed things – particularly for Europe, for whom the consequences of Brexit could be profound. That, in turn, has implications for my fund.
“In some ways, the turbulence in the markets we saw in the initial days after the referendum was a response not to the vote itself, but rather to the lack of coordinated reaction from politicians in the UK and Europe. The real surprise was that neither chancellor Merkel nor prime minister Cameron appeared to have a plan B.
“A quick fix now seems unlikely and a long period of uncertainty lies ahead. Coordinated intervention by central bankers can fix a financial crisis, but this is different. This is a political upheaval without precedent. The UK’s vote to leave may mark the start of the slow disintegration of the EU. The UK will survive, fudging together a solution in typically British style. It may even be in a better place in 10 years’ time. But the European project looks increasingly broken. If the UK leaves the EU, my native Denmark is likely to follow. In this sense, Brexit is a potential ‘game changer’.”
“Given this uncertainty, safe-haven assets, such as government bonds and equities whose earnings are impervious to economic turmoil, are in demand. Value stocks (which trade on a lower multiple of their earnings than the market) are not.
“The Elite Rated Artemis Global Income fund has a significant level of exposure to Europe. It also has a significant bias towards ‘value’. Both characteristics have been deeply unhelpful, more than offsetting the positive contribution from the fund’s stockpicking and currency overlay (we have long taken the view that hedging away some of our currency risk using a short euro / long dollar currency hedge is a sensible precaution).”
“Yet although our positioning has been unhelpful, our response has been measured. Earlier this year, we thought the European economy could start to improve in the absence of an exogenous shock. Brexit has delivered precisely that – and is likely already having a deflationary impact on the ‘real’ economy. So we have not, in general, been adding to our European exposure. “Furthermore, in some cases and under certain scenarios, our financial modelling shows the sharp falls in shares of some of our European holdings to be well-founded. For example, bond yields in Europe now seem likely to remain rooted at record low or negative levels for a long time. So the prospects for European banks have deteriorated too.
“Shares in some insurance companies have also fallen. Again, this may be with good reason. The losses may seem extreme, but if we look at the yield these companies can now expect to receive on their investment portfolios over the coming months and years, the falls may prove justified. So in the case of some European financials, we have cut our losses, selling Spanish bank Santander and Italian insurer UnipolSai. This has been balanced by adding some defensive holdings in the US, such as tobacco companies Altria and Reynolds.
“We are not, however, reinventing the portfolio altogether. Instead, we have been appraising our holdings and the wider market as rationally as possible. In some cases, the sell-off appears to be more about sentiment than fundamentals. We will not run away from assets that are too cheap and whose prospects remain good. We therefore retain our Italian TV and telecoms ‘tower’ companies – EI Towers and Rai Way. Their revenues are predictable and their dividends attractive.
“And we have been adding to some of our European holdings, albeit highly selectively. We have, for example, been adding to infrastructure group Ferrovial. Its shares have been treated harshly; investors seem to be ignoring the significant proportion of its revenues derived from toll roads in Canada. It also owns a stake in Heathrow Airport, which will remain a premium asset levying regulatory-determined fees whether the UK is part of the EU or not.
“We have also been adding to our holding in Eurotunnel, whose shares have fallen even further than some banks. Clearly, the weak pound will hurt a company whose shares are quoted in euros, but which generates half of its revenues in sterling. Even so, the sell-off seems far too extreme. Perhaps it has become a simplistic proxy for investors looking for a way to bet against cross-Channel trade? In reality, this is a long-duration asset: the company has its concession until 2046, by which time Brexit should be distant memory.”
“We are not selling out of Europe wholesale. We are hoping for some policy action to calm markets in the short term. We will continue to use our currency overlay to hedge away some of our exposure to the euro (which may have further to fall). Fundamentally, however, there may be little that can be done in terms of a ‘quick fix’ for Europe. As painful as it is for us to admit, the outlook is far bleaker than we believed.
“But while European financials may now be almost un-investable, prospects for some other stocks look okay. So although we have reduced our exposure to European financials, the prospect of interest rates that are ‘lower for longer’ should be seen as an opportunity for many of our holdings – notably German real estate and some infrastructure stocks – rather than a threat. More broadly, this looks set to be another difficult summer for markets. So rather than taking extreme positions, we continue to proceed with caution.”
Where to next?
Past performance is not a reliable guide to future returns. You may not get back the amount originally invested, and tax rules can change over time. Jacob's views are his own and do not constitute financial advice.
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