Brexit 2016

27 June 2016

Please find the below commentary as general insight on the result of the UK vote to exit the European Union. It is provided for information purposes only.

On Friday, June 24th 2016, UK voters provided a material shock to global financial markets by voting to leave the European Union.

As we have highlighted in recent times, we saw the UK referendum vote as a binary outcome with an asymmetric risk profile to the downside. That is, in the event of an ‘Exit’ vote, the risk to financial markets and risk assets was greater on the downside than the risk of any positive outcome from a ‘Remain’ vote.

There will be a wide range of impacts to global financial markets, however the outcome of this event is unprecedented and the true impact of the UK exit on the global economy is likely to remain highly uncertain in the near term.

Economic growth rates are likely to move lower than current expectations as will the outlook for riskier asset classes such as equities. Politics are also likely to come to the fore in a range of countries, particularly in the UK but also in continental Europe given the upcoming Spanish election and Italian constitutional referendum. Pressure will remain on central banks (particularly the Bank of England, European Central Bank (ECB), and Bank of Japan) to provide further stimulus measures, and markets are likely to price in a cut to the UK policy interest rate in the near term (it has remained at 0.5% since early 2009). The impact will also be felt far wider than the Euro zone and the US Federal Reserve is now even less likely to raise interest rates. It is hard to see any further interest rate rises in the US in 2016.

The outcome in markets to-date has seen a ‘flight to quality’ across a range of asset classes such as government bonds and we expect this will continue to be the case given the uncertain impact of this event. Equities will likely remain volatile and as evidenced today, as the outcome of the vote became clearer in the Asian time zone, selling was noted across all major markets. A number of these markets have now appeared to have hit circuit breakers (where authorities suspend further market trading). Credit markets are also weaker across the board. Currencies have seen very large intra-day moves, and the British Pound hit a 30 year low and has traded in a very large 10% intraday range. The Australian dollar logically fell as did the Euro and capital flowed into the safe haven currencies such as the US dollar and the Japanese Yen.

Atrium has recently moved to reduce its equity exposures across the diversified portfolios in the lead up to the UK referendum given our view that the risk profile of the Brexit vote was not balanced, but rather it was an asymmetric risk profile to the negative. That is, we thought there was far more to lose in the event of an ‘Exit’ vote than there was to gain in the event of a ‘Remain’ vote, and a subsequent reduction in portfolio risk was warranted.

As a result of lowering our exposure to equities we have increased our holdings of cash in the portfolios which we see as both prudent and beneficial in the current environment. Uncertainty will remain for a while as ensuing volatility is realised across a range of financial markets. However, we believe we are well positioned to opportunistically deploy our cash holdings where we have confidence in the future returns of investments for the benefit of our investors.

Given the uncertain impact of today’s outcome, the fallout from the Brexit vote will continue to be play out over coming days and weeks. We will continue to assess all information as it becomes available and will look to provide an update of our additional thoughts in the coming weeks.

We are reminded during these times of heightened uncertainty and market volatility of the benefits of a truly diversified portfolio strategy. By diversifying risk across a range of factors, rather than the portfolio being dominated by any one risk factor (such as equities), it is our view that the potential for preservation of capital exists during times of market stress.

Please feel free to contact us should you have any further queries.