While the ramifications of the Brexit vote are still being priced into markets – a situation that is likely to continue for at least this week if not beyond – we remain vigilant to market movements. And while we have always been an advocate of currency diversification [see our note dated 19.04.16], Friday’s market events proved to be a testing point and a validation.
Going into Thursday night’s count, the Pound-US Dollar was trading at $1.50 and the market was highly confident that the result would be Remain. By 2 a.m. the Pound had dropped to $1.40 and for a while it stabilised at around $1.46 as some big votes came in for the Remain camp around 2.30 a.m. Just over an hour later the Pound had weakened further to $1.36. This amounts to the biggest one day fall for Sterling in at least 40 years (and the fall has extended on Monday 27 June).
Click or tap the image to see the Sterling currency chart on Bloomberg (use your back arrow to return to this page).
Going into the vote, while our expectations of a Remain vote were in line with the market sentiment, we remained cautious about the asymmetric risks in markets: we had reduced our allocation to Euros earlier in the week (seeing risks around the Euro in either a Leave or a Remain outcome) but still held considerable allocations to US Dollars and to a broad range of other currencies, including Japanese Yen. We remained underweight against our long-term strategic allocations to Sterling. We also held recently-added positions in Gold and US Treasuries as potential safe havens.
As the votes were counted, we added to our US Dollar exposure by a further 5%. Market expectations of how far Sterling can fall vary widely, with investors facing deep uncertainty about the political and economic fallout, about the UK’s future trading relationship with Europe and about central banks’ responses, both in the UK and overseas. The UK has a substantial current account deficit, which is sustainable if capital inflows to the economy remain robust; however, in an environment where global investors may be selling Gilts and UK equities, and where long-term foreign direct investment decisions around the UK face additional uncertainties, Sterling may still face considerable headwinds.
Many commentators suggest that Sterling could trade down to a range of $1.20 to $1.30. We are re-testing our own assumptions and continuing to debate market movements and opportunities across all asset classes, assessing where assets may have repriced too aggressively or where market moves may still understate the impact. Watch this space.
And amid the contagion and fall out, our portfolios have held up well so far. While we had added slightly to FTSE 100 exposure a few days before the vote, as market expectations and polls seemed to head back towards a Remain outcome, this step proved to be less damaging than we might have feared. Investors appear to have made a distinction between the global companies in the FTSE 100, who only see an average of around 25% of their revenues coming from the UK, and the more domestically-exposed FTSE 250 stocks, which saw a slide of 7.20% over the day. Our safe haven positions in 10-year US Treasuries have also helped. But it was the currency diversification that provided the biggest benefit.
As a result our portfolios have remained stable across the risk appetites. Our Asset Allocated Passive (AAP) funds’ one day NAV changes, as of day end Friday 24 June, show positive performances of between 0.79% through to 1.89%.
The Balanced fund in particular benefited from being invested in the sweet spot of foreign currency exposure, while also holding a 4% gold position and US Treasuries. Gold is our only commodity position, which has also paid off.
We realise that markets will continue to move violently as the implications run through investors’ minds and this performance does not guarantee future gains given the severity of the situation. The political uncertainty in the UK, in particular, causes concern, with a wide range of possible scenarios around how, or when, the UK will formally begin the process of exit negotiations. Investors are also considering the implications for Europe, and whether the vote will drive the members of the EU to reform and move closer together, or to pull away from each other.
While we have our own watch list and position limits, our cash holding of 9% (in a Balanced fund) gives us options to look at opportunities where we believe that they have become oversold based on the fundamentals, which we believe will be the basis for valuations in the long run.