Brexit has taken the world by surprise. Now that it is a reality, investors have to adjust to it. Investment managers had to go back to the drawing board and re-evaluate their models, factoring in a European Union without the UK. In the following question and answer explanation Kristian Camenzuli, equity investment manager, tackles questions on the equity market, while Jordan Portelli, fixed income investment manager, tackles the fixed income market.
The FTSE 100 is outperforming other European Indices despite Brexit. Why is this?
KC: With all that has been going on in the UK, few are those who would have anticipated that the FTSE 100 would be the best European Equity Index so far this year.
The biggest gains since the referendum have been made by gold miners, exporters with big dollar earnings and companies with stable incomes such as pharmaceutical groups, utilities and food and drink companies. Housebuilders, banks and airlines have led the declines.
The four main reasons for the outperformance of the FTSE 100 are as follows:
A weak sterling: this is good news for those companies who have large overseas earnings, and these account for about 77 per cent of the index. As the pound falls against the dollar and euro, exporters find their goods are cheaper for overseas customers to buy, which boosts their sales and profits.
A bottoming of commodity prices: the largest sector exposure in the FTSE 100 is the oil and gas industry. With a bottoming of the oil price and a weaker sterling, companies like BHP Billiton and BP continue to do well as their product become more attractive to foreign consumers.
Attractive dividend yields: with interest rates so low, the dividend yield on the FTSE 100 above four per cent makes investing in the market an attractive option when compared to the yield on other asset classes for a similar level of risk.
An accommodative Bank of England (BOE): in August the BOE cut its official interest rate to 0.25 per cent, the first such move since March 2009. It also plans to pump an additional £60bn into the economy to buy government bonds, extending the existing quantitative easing programme to £435bn in total.
Which companies within the UK are benefitting from Brexit?
KC: There is no doubt that the companies within the UK which are benefitting most from Brexit are the miners.
Anglo American which is the best performing stock in the index is up 167 per cent so far this year, followed by Fesnillo, Glencore and Randgold, which are up 128 per cent, 96 per cent and 77 per cent respectively.
The outstanding performance of miners can be attributed partly to a rebound in the gold price. Gold spiked following the vote to leave the EU as investors shifted to safe heavens. Continued uncertainty around how the UK will negotiate the terms of its EU exit means that the price of gold could keep rising – maybe to as high as $1,424 an ounce by the end of the year, according to a survey of analysts.
However, it is not just the miners that benefitted from Brexit but also the exports, which benefitted from a strong depreciation of sterling.
As the pound falls against the dollar and euro, exporters find their goods are cheaper for overseas customers to buy
Companies like Smiths Group, Micro Focus International and 3I Group are up 43 per cent, 35 per cent and 28 per cent respectively. This positive performance is mainly attributed to the weakness in sterling due to the fact that the main markets of these companies are outside the UK itself.
Which sectors within the UK should an investor avoid due to Brexit?
KC: The sectors in the UK which are performing poorly are mainly the real estate, retail, airlines and financial sectors. The negative performance is mainly due to a result of negative sentiment and uncertainty on the future of the UK economy.
It is immediately visible in the real estate sector. Retail investors withdrew £1.4bn from property funds in June, six per cent of the sector’s assets, as the Brexit vote sparked an exodus that forced some of the largest funds to halt trading. We remain underweight in these sectors until we get further clarity of the UK’s position with the EU.
Q: The BOE acted aggressively following the result. What was the immediate implemented stimulus?
JP: The market was pricing a rate cut by the BOE. However, the stance was more aggressive than expected. Apart from the rate cut from 0.50 per cent to 0.25 per cent, the BOE implemented a Term Funding scheme of up to £100bn with the aim of the scheme to ensure that the cut to the base rate is passed through to households and companies. In addition, the purchase of up to £10 billion in UK corporate bonds was also announced, while the bond buying programme better known as quantitative easing was increased by £60 billion of monthly purchases from £375bn to £435bn.
Q: Do you envisage any problems for UK corporate bond issuers?
JP: Undoubtedly, the theoretical implication of easing measures by Central Banks is a weaker currency, which implies a competitive advantage for UK exporters. Thus for major exporting UK corporate issuers the implication of a weaker currency will indeed imply higher exports. For corporate issuers with domestic demand, the situation is still unclear due to the fact of the uncertainty in terms of the impact on the economy going forward. Another interesting point is that the rate cut implies that now issuers can re-finance at lower interest rates and thus reduce their interest expense.
Q: Are UK bonds still attractive?
JP: As said, the effectiveness of the latest implemented stimulus is uncertain. Thus the possibility of further stimulus is surely on the table. This was also confirmed by BOE Governor Mark Carney who stated that although he doesn’t fancy negative interest rates, the possibly of going towards that path is a possibility if need be.
In my view, sterling bonds should still offer some value going forward and thus investors who hold sterling cash should consider seeking an allocation in UK bonds within their portfolios. The rationale is based on the fact that dependent on the economic situation, the BOE will adjust its stimulus accordingly. There is still a strong possibility of further stimulus going forward and thus this will translate in higher bond prices. A more prudent approach is to select UK issuers which have a high exporting element. These will surely benefit both from further stimulus, but also from an improvement in the issuers’ financial health due to an increased competitive advantage in terms of exports.
The information, views and opinions in this article are being provided solely for educational and informational purposes and should not be construed as investment advice, advice concerning particular investments or investment decisions or tax or legal advice.
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Kristian Camenzuli and Jordan Portelli are investment managers at Calamatta Cuschieri Investment Services Ltd.