Brexit: an update on our portfolio positioning
A UK election now looks very likely, but other Brexit outcomes are harder to predict. Our portfolios are well positioned for the months ahead – whatever the future may hold.
Boris Johnson’s prorogation of Parliament draws on a tactic that allowed Charles I to rule for 11 years without political interference – and ultimately led to civil war. Little wonder it arouses such strong feeling today. Nobody knows how the next few weeks and months will play out.
One consistent feature of the period since the 2016 referendum has been the wide range of potential outcomes. That situation remains very much the case today, with the added complexity of a likely general election. The probability of an election this year is now 92%, according to the latest odds from bookmakers Betfair. Other outcomes are far less certain: the likelihood of a no-deal Brexit in 2019 and a revocation of Article 50 both stand at roughly 25%.
How do we manage wealth in such uncertain times?
The philosophy behind our investment process aims to construct portfolios that protect clients’ assets whatever the future may hold. We follow developments closely, but avoid knee-jerk reactions to the twists and turns of political events that capture headlines. Over time, however, our process does respond to longer-term economic developments and other factors including valuations and market sentiment. We provide below some insight into how portfolios are currently positioned, looking at currency risk, geographic exposure and asset allocation.
Sterling weakness has helped – so far
We have significant holdings of overseas assets, which have increased in value in sterling terms as the currency has depreciated. A “no-deal” Brexit would very likely see sterling fall further. This would further increase the value of our overseas holdings, acting as a natural hedge in what could be a difficult period for UK assets.
Conversely, we think a Brexit delay – or deal – would likely see a rally in sterling, which could weigh on performance in sterling. However, at this juncture, a Brexit deal may involve an interim arrangement opening the door to further negotiation or interpretation of what has already been agreed in any ‘political agreement’ – and continued uncertainty.
As a result, although we do not envisage sterling quickly returning to the levels that prevailed before the Brexit referendum, it could rally in the shorter term.
We have the ability to hedge foreign currency risk, and can reduce it on a tactical or shorter-term basis. We can use currency-hedged share classes of collective funds. We also have the ability to use currency forwards and other derivatives to reduce currency risk.
We remain neutral on equities
Whatever is going on in the wider world, there are still many companies with healthy balance sheets and growing profits. In the long-term, we believe that owning shares in these companies is the best route to investment success.
However, a number of risks keep us at neutral. The key one is an escalation of the US-China trade war, which would weigh on global economic activity and could put an end to corporate profit growth. There is also a risk that inflationary pressures may be building, with unemployment very low in the US and other major economies. This could result in the Federal Reserve having to pivot back toward higher interest rates, which would come as an unwelcome surprise to equity markets.
Finally, on certain measures, valuations are above their long-term averages – though not at extreme levels. The trade off of risk and reward becomes less favourable when shares are more expensive.
In itself, Brexit has not impacted our view on equities as an asset class. However, we see rising political risk on many fronts. The underlying tensions which give rise to these phenomenon may not be resolved quickly and could potentially have disruptive consequences.
Our exposure to UK shares is meaningfully lower than in the past
We have been reducing our allocation to UK equities for several years now. This will dampen the impact of any sharp moves in UK stocks – in either direction – over the coming months. This reduction has been a response to the distinct sectoral weightings of the UK market, rather than a reflection of our views on Brexit.
Natural resource companies account for a quarter of the FTSE 100’s market value, for example, more than twice their weighting in other developed equity markets. Technology, by contrast, is under-represented in the UK. Given this composition, the UK market looks less able to benefit from technological disruption. We want to ensure that our portfolios are positioned to benefit from this powerful force, rather than be hurt by it.
How market composition differs
Source: Bloomberg, 2019
Preference for alternative assets and cash over bonds
We have benefitted from the rally in government bonds, which now sees many bonds trading at all-time highs. However we are comfortable with an underweight position. Given that the yields on offer in major governments bond markets are in general below inflation, it is unlikely that the asset class will be a driver of real returns in future.
We believe that alternative assets have an important role to play as diversifying assets in long-term portfolios. Gold – to which we have a large allocation – has been performing well as central banks ease monetary policy and geopolitical tensions rise. Real assets such as infrastructure and renewables that produce long term visible cash flows, continue to be attractive. We retain our allocation to trend-following funds that have historically performed well when equity markets struggle.
Finally, in uncertain times, a higher than average cash position can be of great value. It allows us to swiftly take advantage of investment opportunities – whether these arise as a result of sudden shocks related to Brexit, or other causes.
Chief Investment Officer
Caspar Rock joined Cazenove Capital in September 2016 and is Chief Investment Officer. He joined from Architas Multi-Manager Ltd, a part of the AXA group, where he was Chief Investment Officer and responsible for all aspects of the investment activities, including investment philosophy, process and team. He also oversaw portfolio management at two of AXA group’s private banks. He previously headed up the multi-manager business at AXA Framlington from 2006 to 2008. Prior to that, he managed a range of directly invested equity and bond portfolios, and was Head of European Equities at Framlington as well as a member of the Healthcare team. He has 33 years’ investment experience.
The opinions contained herein are those of the author and do not necessarily represent the house view. This document is intended to be for information purposes only. The material is not intended as an offer or solicitation for the purchase or sale of any financial instrument. The material is not intended to provide, and should not be relied on for, accounting, legal or tax advice, or investment recommendations. Information herein is believed to be reliable but Cazenove Capital does not warrant its completeness or accuracy. No responsibility can be accepted for errors of fact or opinion. This does not exclude or restrict any duty or liability that Cazenove Capital has to its customers under the Financial Services and Markets Act 2000 (as amended from time to time) or any other regulatory system. Cazenove Capital is part of the Schroder Group and a trading name of Schroder & Co. Limited 12 Moorgate, London, EC2R 6DA. Authorised by the Prudential Regulation Authority and regulated by the Financial Conduct Authority and the Prudential Regulation Authority. For your security, communications may be taped and monitored.