The search for value across traditional asset classes continues to look challenging in the post-Brexit environment.
At a recent roundtable examining the impact of the UK’s decision to leave the European Union, Money Marketing and Fund Strategy invited experts from across the asset management industry to discuss the post-Brexit investment landscape.
Panellists argued the UK’s prospects were already being challenged even before the EU referendum. They said the immediate draw of so-called “bond proxy” assets such as the tobacco sector was testament to a UK-centric, yet still nervous, investor appetite.
Hargreaves Lansdown senior analyst Laith Khalaf said for investors seeking income, including the millions of baby boomers hitting retirement, UK equities were “the only game in town”. He expects UK equity income funds to hold firm for retail investors.
He said: “I expected retail money would move into the bond proxies, as we have already seen. In an environment with no or low growth, with bond yields where they are, for companies delivering earnings growth year in, year out and which have been doing so for the last 10 or 15 years without a financial crisis, you will always pay a premium. You will not get as much income as you probably want, but at least you are going to get some.”
He pointed to oil and gas as a sector that might present some decent yield opportunities. He said while this market came with inherent risks, these are not Brexit-related but rather down to the economics of the natural resources sector.
City Financial investment director Peter Toogood was less optimistic on very focused strategies. He believes the burning issue to be the inability to find value accurately because asset prices have been manipulated for so long.
Toogood rejected the idea bonds were overvalued, and argued investors were suffering from what he dubbed “financial terrorism” with “state-sponsored bombs” because the Bank of England’s loose monetary policy was forcing investors into assets, but not necessarily at the right price.
He said: “So many of the fund managers we meet sit and look at you with white faces because most of them know there is no absolute value – certainly not against bonds where someone is fixing the price by driving down yields.”
Toogood was sceptical over the benefits of ongoing quantitative easing, claiming Bank of England governor Mark Carney had effectively “run out of road”.
Panellists agreed that never before has the case for diversification been stronger. They discussed how equities maybe the only true income play and how bond yields are looking less attractive by the day.
They also reflected on the inherent risks of investing in commercial property funds, a sector forced into the spotlight in recent weeks after most major UK commercial real estate portfolios were forced to halt redemptions as investors hauled their money out post-Brexit faster than the underlying assets could be sold.
Khalaf said: “Given what we have seen over recent weeks we are reminding investors of the benefits of diversification and how a globally diverse portfolio can help you out in a situation like this. And obviously by investing in UK-listed companies you are still accessing global exposure.”
The characteristics of “traditional” asset classes have been called into question since the financial crisis. Panellists felt that now more than ever, investors need to consider their asset allocation – and adjust expectations accordingly.
Morningstar chief investment officer for EMEA Dan Kemp challenged the role of fixed income in portfolios, and suggested 10-year gilts might be an expensive way to insure against short-term volatility. He said the challenge, given the encroaching threat of negative interest rates, was achieving a positive real return.
He said: “People need to think now very carefully about why they are even holding bonds because if they are not a real source of return, the question is, what do they bring to the portfolio?”
Kemp talked about the collateral damage following the referendum result, where indirectly affected assets were hit, such as Japanese equities.
He warned of assets whose fair value had been challenged, such as European financials, and the challenges around whether certain assets were “cheap for a reason”.
He said: “Their price has fallen a long way but the fair value has potentially changed as well, so we are spending a lot of time focusing on those type of assets and trying to think through what a new a fair value would be. The question is whether they are actually cheap, or just visibly cheap because they have fallen.”
Some of the best UK and European value opportunities would sit in the “eye of the storm”, he said, but it would take time for their true value to emerge.
Kemp added: “Post-Brexit we do not find ourselves in an environment where we look across the vista of capital markets and see lots of opportunities.”
Panellists also discussed whether the need to diversify, on top of pressure on fees, offers an opportunity for multi-asset funds to innovate and set themselves apart from their rivals.
JP Morgan global market strategist David Stubbs said by accessing a broad range of assets, many previously unavailable to retail investors, true diversification is easier to achieve. He argued as traditional assets look expensive and struggle to deliver real returns, liquid alternatives may be a solution, forming a new cornerstone to an investment portfolio.
Stubbs said while historically issues with hedge funds have been over fees, fund groups able to develop more innovative products at a lower cost will flourish.
He points to derivatives-based strategies such as market-neutral, long/short credit and absolute return as good “anchors” to a retail investment portfolio, when bonds are probably overpriced. He said: “You can get many of these for very cheap fees though they are not going to shoot the lights out. On a good year they give you 5 per cent, on a bad year they lose you 2 per cent. Most of the time it will be somewhere in the middle.”
He suggested as the correlation between bonds and equities becomes more volatile, there is a resistance to moving overweight equities or traditional bonds in either direction.
Stubbs said: “We do not think government bonds are giving us the downside protection they used to, which is one of the reasons why we are still overweight credit and mostly in the developed world. For a number of reasons we think that is the best place to get risk-adjusted returns.”
Tom Frackowiak, executive director at Cicero, recognised the opportunity, not only for his own company, but for the financial services sector as a whole. He said: “With this huge change there’s actually quite a lot of opportunity. A lot of financial services companies over the years have increasingly recognised political risk as an issue that they need to factor into their business.
“What we have seen as a small consultancy [with international presence] is that market reaction has come about quite quickly. In previous downturns, business decisions get put off or delayed. Yet we have seen the reverse over the last [few] weeks. We’ve actually seen businesses coming to us and commissioning work at a lot quicker pace but the reality is that, especially in London, nothing has really changed, though uncertainty is the word.”
But Kemp argued while product innovation is always welcome, investors need to beware of fads.
He said many products have “promised the earth and failed to deliver” over his investment career. He said this was often the reason investors kept coming back to traditional asset splits, with so many alternative strategies having disappointed in the past.
Kemp said: “There is still a need to develop new products but I would argue what we need is cheaper products as cost is one of the key determiners of return.
“We need to bring down costs and make the products more competitive. Often for cost reasons we see them sneaking in equity market beta and ultimately end up sowing the seeds of their own mistakes.”
He said while there were certain products that he respected, they were the exception rather than the rule and in general the product set lacked quality.
Graeme McColgan, financial planner at Million Plus Financial Planning, said take-up of these products has been slow.
He said: “People are tending to remain with their chosen provider, not go out and discover these new products as they move into drawdown, but we believe there are still not enough people using these new innovative products – every week we see a new solution coming out and more will continue to be developed but we still don’t see enough clients making those active choices when it comes to their retirement options.”
Khalaf highlighted the lack of a track record with many market-neutral or alternative strategies available in the retail space.
He named JP Morgan, Troy and Newton as groups offering products with demonstrable performance history.
He said: “Very few have been through an economic cycle because most have been launched in the past three or four years. As fund selectors that is our problem. You are being asked to trust the manager when they cannot provide any real proof of their ability.”
Khalaf admitted some products “got it wrong sometimes” but that could be forgiven because “looking at the whole piece they have probably got it right more often than they have got it wrong”.
He said a more important factor when it comes to investment performance was asset allocation, rather than the more scientific process of stock selection.
Khalaf added: “I feel far more confident saying someone has skill at stock selection than they do at asset allocation.”