Fund Management Diary Meeting held on 28 June 2016 Brexit - The Hail Mary Pass Prior to the Brexit vote when David Cameron was interviewed on Radio 4 and asked if he would resign if an Out vote occurred he replied that he would go to work on Friday morning, whatever the outcome, and carry out the will of the British people. In the event, this is not what occurred as when he appeared after the vote, following what was clearly an emotional defeat, he resigned. He suggested that his successor should take over before October and trigger Article 50 of the Lisbon Treaty, which would formally begin the untested process by which a member state leaves the an Union. A Hail Mary pass is a very long forward pass in American football made in desperation with only a small chance of success. As a firm Remain campaigner this was the final option available to Mr Cameron to avoid triggering the irreversible Article 50 and instead create some time and space for any other developments, which could avoid the outcome he desperately believes to be against the national interest. Key an leaders have been quick to defend against this tactic. has significant problems and providing an easy exit for the UK will encourage others to pursue a similar path. The President of the an Commission, Jean-Claude Juncker, has insisted that the UK now triggers Article 50 without delay with French, German and other leaders insisting that no negotiations of any kind (formal or informal) can begin until this occurs. Once Article 50 is triggered, the UK will be cut out of EU decision-making at the highest level and the only way back is by unanimous consent from all other members, so it is effectively a one way process. In the meantime, the UK remains bound by all other membership requirements of the EU including the contentious requirements of free movement of people and contribution to EU budgets. The process is mandated to only take two years and again all members must consent if any extension is granted. The work and skill required to negotiate a successful exit is considerable and it is not realistic to expect that 43 years of an integration can be undone in such a short timeframe. Since the outcome of the referendum was announced, events have moved quickly. Stock markets have fallen around the world and the pound has devalued by around 10% to date, to a 30 year low. The political landscape has changed considerably as the Labour party has disintegrated, with the majority of the shadow cabinet resigning, and the Conservative party moving into a new leadership contest. Scotland and Northern Ireland voted to remain part of the EU and the Scottish National Party are looking at options of independence once again, and also the possibility of blocking the UK exit from the EU in Parliament. Standard & Poor s and other rating agencies have reduced their view of the creditworthiness of the UK, warning of further downgrades due to lower economic growth expectations. This has not
negatively impacted the value of Government debt, which has soared to record highs as 10 year yields fall below 1% on the expectation that UK interest rates will remain lower for longer. Nick Clegg has called for an early general election on the basis that it would be undemocratic for a new Conservative leader to be elected by the Conservative party given that the whole nature of British politics has changed and the manifesto commitments of the current Government are now largely irrelevant given the new Brexit mandate. A general election was not ruled out by Mr Cameron who felt this would be a decision for the next Conservative leader, although we feel this is unlikely. The effect to date for investors has been varied and some investors will be surprised that their portfolios have risen sharply as a result of Brexit. Investors who hold overseas assets or UK fixed interest investments will have seen positive returns. Since the beginning of June, the FT World Index is ahead by around 3.5% as overseas assets have benefitted from the devaluation of Sterling as foreign currencies become more valuable. UK Gilts have risen by around 4% as future interest rate expectations have subsided and the safe haven status has attracted inflows during the current uncertainty. Sterling-based equity investments have suffered the most extreme losses with medium sized companies falling by around 14% and smaller companies by 10%. The FTSE 100 has been more resilient, falling by only around 3%, which is largely due to the high level of foreign earnings in these companies which, again, benefit from weaker Sterling. So where has this left the average UK investor? The Investment Association publishes various benchmarks which represent managed funds covering the key risk areas. These benchmarks are 0-35% Shares, 20%-60% Shares and 40%-85% shares. Since the beginning of June to date, these benchmarks are showing returns of +1.01%, +0.17% and -0.05% demonstrating that diversified portfolios have generally smoothed out the recent volatile swings, leaving investors generally ahead of valuations immediately prior to the referendum. Investment markets have effectively granted many investors their own Hail Mary pass opportunity, as anyone wishing they had panicked out of their investments pre-referendum can now do so knowing the result and at a profit to pre-referendum levels. The key question is should they? There are more positives than investors perceive right now. The devaluation in Sterling is something which many Western economies have being trying to achieve for many years. Japan, most notably, has had the most aggressive money printing policy combined with negative interest rates but the Yen has remained stubbornly expensive. The benefit of a weak currency is that exports become cheaper and imports more expensive, boosting demand for domestic goods and services. The Brexit effect has created a 10% price cut for UK exporters. Companies trading with the EU are unlikely to benefit due to the increased uncertainty with regard to future UK access to the free market, but export businesses trading internationally outside of the EU will be celebrating. Most would accept that the EU project has been failing in recent years with the credit crisis exposing the huge economic imbalances which exist within. Youth unemployment of 50% in many south an countries presents a huge problem and the financial discipline which Germany insists upon has condemned many members to years of negative growth with no immediate solution in sight.
an politics has become increasingly detached from an democracy and the British referendum has exposed this fact in a manner that cannot be ignored by any member state. must reform to survive and leaving a failing project may work but remaining part of a reformed may also be logical. This opportunity may ultimately present itself, but this cannot be a short term consideration. The short term uncertainty is very high. Who will be the next Prime Minister? If or when will they trigger Article 50? How long will the exit take and what will it look like? Who will lead the Opposition? Will Scotland and Northern Ireland remain in the UK? We have developed an expected framework around these unknowns so that we can monitor outcomes to our initial expectations. We expect the next Prime Minister to be elected by the Conservative party on the basis of a moderate Brexit mandate and be in place by September. At this point, will be successful in forcing the Government to trigger Article 50 and begin negotiations. Political posturing from Scotland and Northern Ireland is unlikely to result in any potential independence vote until the future position of the UK within is established, as voters will not want to make this decision without this information. Once negotiations begin, it will become clear that the pace of the UK withdrawal from will be much slower than many of the Leave camp initially expected. This is effectively a divorce where there is much at stake. The children of the divorce are around 3 million EU nationals who live in the UK and around 1.2 million UK nationals who live in whose rights must be agreed. The financial implications are the 8Bn per annum ( 121m per week) net contribution (source: BBC) and the significant trade generated via our access to the single market which is vital to both sides. There is also the additional burden of replacing or adopting an legislation once the UK has left the EU. Given the size of the challenge and the need for to agree our exit with the agreement of the remaining 27 members, the prospect that this can be completed in two years is unrealistic given the issues at stake and the previous pace of an negotiation around serious issues such as the Greek debt crisis. If the EU does insist on the UK leaving within the two year timeframe, the exit will be rushed and poorly orchestrated with significant economic damage caused to both sides. Therefore we expect that a gradual exit programme will be agreed with the UK leaving the EU within the two year timetable but moving to an EEA plus or minus (an Economic Area) position. This will continue our access to the single market whilst also requiring the UK to contribute to the EU budget and adopt EU legislation. This initial change will not result in any significant difference to the current position except that we will lose our voice in but gain some control of EU immigration with the ability to negotiate trade agreements outside of the EU. From this position, further withdrawal may occur over the following years with access to the single market being reduced if we cease to contribute to the EU budget and/or impose significant restrictions on EU immigration. During this process, the door back into the EU will remain open should the EU reform and become more compatible with the will of the British people. From an investment perspective, the referendum result was a shock to global markets and initial thoughts were of a disorderly and rushed exit from the EU. As the initial shock subsides, it will become clear that this exit will be over a number of phases and on a glacial time basis rather than a quickie divorce. The uncertainty will continue and lead to market volatility and the EU may start to realise that reform is needed for its survival and this would be a positive outcome.
In the meantime we continue to believe that investors should accept the volatility of equity markets for modest medium and long term returns rather than the near-zero return of cash and bonds. Strategy The Margetts funds have generally performed well in the few days since the referendum result as our preference to larger value-orientated companies and international holdings have out-performed. Our lower risk portfolios have lagged a little due to underweight exposure to gilts although our long-term negative view on this asset class has not changed. The higher risk portfolios have risen significantly due to currency movements. We do not intend to make any significant changes during this period of volatility however we are likely to make small reductions to our an exposure as we believe that recent events have increased political risk further in this region. Providence Asia Pacific UK Equity Income 38% Bonds 32% Other 5% Money 13% Select USA 12% Asia Pacific 12% UK Equity Income 19% UK 19% 11% Bonds 14% Money 7% Emerging
International USA 3 Asia Pacific Money 12% 1% Emerging 9% 21% UK 15% Japan Venture Specialist Other 7% UK 5% USA Asia Pacific 3 10% Emerging 29% Money 1%
Important Information Please note that the contents are based on the author s opinion and are not intended as investment advice. This information is aimed at professional advisers and should not be relied upon by any other persons. Any research is for information only, does not constitute financial advice or necessarily reflect the views of the author and is subject to change. It remains the responsibility of the financial adviser to verify the accuracy of the information and assess whether the fund is suitable and appropriate for their customer. Past performance is not a reliable indicator of future performance. The value of investments and the income derived from them can fall as well as rise and investors may get back less than they invested. Important information about the funds can be found in the Supplementary Information Document and NURS-KII Document which are available on our website or on request. Issued by Margetts Fund Management Ltd Margetts Fund Management Limited is authorised and regulated by the Financial Conduct Authority For any information about the company or for a copy of the company's Terms of Business, please contact the company on 0121 236 2380 or at 1 Sovereign Court, Graham Street, Birmingham B1 3JR You can e-mail us at admin@margetts.com