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Brexit: Order from Disorder

June 24, 2016  | by Mark J.P. Anson, Michael Strauss

Investment Strategy | Market Commentary

Summary

  • The surprise Brexit vote has resulted in a sharp sell-off of equity markets globally

  • The declines, however, have been remarkably orderly with markets moving mostly sideways after initial drops

  • We do expect continued volatility in the coming weeks as markets assess the impact of the U.K. vote

  • Generally speaking, our portfolios have been underweight Europe for some time and we anticipate they will continue to be for the foreseeable future


The UK’s vote to leave the European Union (EU) has sent shock waves through the capital markets throughout the day today. The 52%/48% vote to leave the EU was a significant surprise, as most polls had the “remain” camp winning. Prior to today, world equity markets were largely up over the past week reflecting a similar “remain” outcome. Importantly though, while today’s moves were sizeable, with European stock markets down 10 to 15 percent in U.S. dollar terms, U.S. equities held in well on a relative basis.  The S&P 500 Index, as an example, dropped about 3.5 percent Friday, but was still hovering within its 100 point trading range over the last several months.

On balance, our underweight to European equities has served us well in this environment as have our overweight to high quality lower-volatility and lower-beta domestic equities and a more cautious underweight allocation to emerging markets, resource entities, and inflation-hedging strategies.  We continue to favor this course of action.

The Global Impact | Contagion or Containment?

Despite the results of the vote in Europe, it is important to remember that the U.K. represents just two percent of world growth and the full Eurozone accounts for only about 16 percent of the world’s economy.  Risks of a broader impact of the U.K. vote are significant, and the fear of market contagion to the U.S. has increased.  However, we believe the true risk to economic contagion in the U.S. is still extremely low.  If U.S. exports to Europe dropped 5 to 10 percent it would equate to just a rounding error for U.S. real GDP.  Domestic-focused U.S. companies should weather the storm that is brewing in Europe better than non-U.S. entities.

The political consequences could turn out to be significant not only in the U.K., but elsewhere in Europe where key elections will take place beginning this weekend in Spain and culminating with the German election next summer.  These political consequences will likely have economic and market repercussions.  Anti-EU views are rising in many countries including now Austria and Germany — and this goes beyond the battle on immigration issues. This warrants increased caution towards this region of the world as well as those countries and companies that are closely tied to Europe. Resource providing companies and emerging economies in Eastern Europe could also be vulnerable. The vote in the U.K. appears to be the start of the next chapter that is now challenging the structure of the European Union which adds to risk and still favors an underweight to the public markets in Europe. European currencies are likely to continue to weaken reflecting greater political uncertainty and risks, combined with more challenging near term economic conditions including a return to recession for several countries. Ultimately, a weaker currency is likely to be combined with more fiscal and monetary policy stimulus to eventually provide a boost to economic activity, but this process is likely to take months or even years to unfold and it pays to be patient and a bit late, rather than early and wrong.

Where to Deploy Risk Assets

We and our managers continue to see opportunities in domestic high-quality U.S. companies with strong cash flows, earnings, and dividends secured by earnings that should weather well in this difficult environment.  Several domestic sectors may also receive support from the increased likelihood that interest rates will stay lower for longer.  Net, we continue to favor an overweight to domestic-focused low volatility and low beta stocks and an underweight to Europe and many areas of the emerging world.

We are looking for opportunities to buy assets at more favorable valuations in the coming weeks and months, with the turn likely to take place first domestically and then eventually internationally. In the interim, the scarcity and demand for capital in many areas of the world may plant the seeds for investment opportunities from private sources that can be the provider of liquidity and capital in a more challenged world at more favorable entry valuations.

Guidance for Long-term Investors

As we have stressed in the past this is likely to be a low return world with more volatility, and many of our client institutions will be ending their fiscal years this month or taking a mid-year assessment of their fiscal condition.  In this context it is important for investors to revisit their asset allocation, broader investment policy statements, and spending policies.

While human behavior often conditions us to “do something” in response to external stimuli, the most important guidance we offer clients is to be patient and stay the course. In counseling our clients not to focus inordinately on short-term market swings, we do recommend that you plan for the challenges of tempered returns over the next five years.  Believe in your policy portfolio and your Investment Policy Statement (IPS); however, revisit your assumptions and make sure that your IPS accurately reflects your risk tolerances and goals.  An effective IPS is a dynamic investment framework to guide your decisions through market cycles.  It should be flexible, but with sufficient rigor to protect against the temptation to over react and “trade” out of down markets.

Authors

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Mark Anson is the Chief Executive Officer and Chief Investment Officer of the Commonfund and Chairman of the Board of Commonfund Capital Inc. and Commonfund Asset Management Company. Previously, he was the President and Chief Investment Officer for the Bass Family Office of Ft. Worth, Texas which was recognized as Family Office of the Year for 2014 & 2015. He was the President & CEO of Nuveen Investments, and Nuveen Alternative Investments, a full service asset management company with over $250 billion in assets under management. Prior to Nuveen, Mark served as the Chief Executive Officer and Chief Investment Officer for the British Telecom Pension Scheme (BTPS), the largest institutional investor in the UK with assets of £65 billion. In addition, Mark was the CEO of Hermes Pensions Management in London, a £55 billion asset management company that is wholly owned by the BTPS. Prior to joining BTPS, he served as the Chief Investment Officer of the California Public Employees' Retirement System, the largest institutional investor in the United States with over $300 billion in assets. Mark is currently a Trustee for the $65 billion UAW Medical Benefits Trust. He also serves on the Law Board of the Northwestern University School of Law, the Board of the Toigo Foundation, and the Board of Panagora Asset Management. He is the only person to have served on the Board of Governors for both the CFA Institute and the CAIA Association.

Mark has published over 100 investment articles in professional journals and has won three Best Paper Awards. He is also the author of five financial textbooks including the Handbook of Alternative Assets, which is the primary textbook used for the Chartered Alternative Investment Analyst program. Mark earned a B.A. in Economics and Chemistry from St. Olaf College, a Ph.D. and Masters in Finance from Columbia University Graduate School of Business, and a J.D. from Northwestern University School of Law, all with honors. He has also received several industry awards in recognition of his leadership in asset management. Last, Mark has earned the Chartered Financial Analyst, Chartered Alternative Investment Analyst, Certified Public Accountant, and Chartered Global Management Accountant professional degrees, and he is a Member of the Law Bar of New York and Illinois.

Mark Anson, PhD, CFA, CAIA
Chief Executive Officer and Chief Investment Officer

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Information, opinions, or commentary concerning the financial markets, economic conditions, or other topical subject matter are prepared, written, or created prior to printing and do not reflect current, up-to-date, market or economic conditions. Commonfund disclaims any responsibility to update such information, opinions, or commentary. To the extent views presented forecast market activity, they may be based on many factors in addition to those explicitly stated in this material. Forecasts of experts inevitably differ. Views attributed to third parties are presented to demonstrate the existence of points of view, not as a basis for recommendations or as investment advice. Managers who may or may not subscribe to the views expressed in this material make investment decisions for funds maintained by Commonfund or its affiliates. The views presented in this material may not be relied upon as an indication of trading intent on behalf of any Commonfund fund, or of any Commonfund manager. Market and investment views of third parties presented in this material do not necessarily reflect the views of Commonfund and Commonfund disclaims any responsibility to present its views on the subjects covered in statements by third parties. Statements concerning Commonfund’s views of possible future outcomes in any investment asset class or market, or of possible future economic developments, are not intended, and should not be construed, as forecasts or predictions of the future investment performance of any Commonfund fund. Such statements are also not intended as recommendations by any Commonfund entity or employee to the recipient of the presentation. It is Commonfund’s policy that investment recommendations to its clients must be based on the investment objectives and risk tolerances of each individual client. All market outlook and similar statements are based upon information reasonably available as of the date of this presentation (unless an earlier date is stated with regard to particular information), and reasonably believed to be accurate by Commonfund. Commonfund disclaims any responsibility to provide the recipient of this presentation with updated or corrected information. Past performance is not indicative of future results. For more information please refer to Important Disclosures.

Disclaimer

Information, opinions, or commentary concerning the financial markets, economic conditions, or other topical subject matter are prepared, written, or created prior to printing and do not reflect current, up-to-date, market or economic conditions. Commonfund disclaims any responsibility to update such information, opinions, or commentary. To the extent views presented forecast market activity, they may be based on many factors in addition to those explicitly stated in this material. Forecasts of experts inevitably differ. Views attributed to third parties are presented to demonstrate the existence of points of view, not as a basis for recommendations or as investment advice. Managers who may or may not subscribe to the views expressed in this material make investment decisions for funds maintained by Commonfund or its affiliates. The views presented in this material may not be relied upon as an indication of trading intent on behalf of any Commonfund fund, or of any Commonfund manager. Market and investment views of third parties presented in this material do not necessarily reflect the views of Commonfund and Commonfund disclaims any responsibility to present its views on the subjects covered in statements by third parties. Statements concerning Commonfund’s views of possible future outcomes in any investment asset class or market, or of possible future economic developments, are not intended, and should not be construed, as forecasts or predictions of the future investment performance of any Commonfund fund. Such statements are also not intended as recommendations by any Commonfund entity or employee to the recipient of the presentation. It is Commonfund’s policy that investment recommendations to its clients must be based on the investment objectives and risk tolerances of each individual client. All market outlook and similar statements are based upon information reasonably available as of the date of this presentation (unless an earlier date is stated with regard to particular information), and reasonably believed to be accurate by Commonfund. Commonfund disclaims any responsibility to provide the recipient of this presentation with updated or corrected information. Past performance is not indicative of future results. For more information please refer to Important Disclosures.