Any port in this Brexit storm – but which port?
When Mystery Cruises plc set sail for the voyage of a lifetime on HMS Brexit, few envisaged the stormy waters ahead. We were barely out of the harbour before apprehensive passengerspleadedto remain in port. And as the voyage continued, the turbulence has brought chronic seasickness.
Two-and-a-half years on and queues are forming at the lifeboats. Last week more than £21 billion was wiped off the value of Britain’s Brexit-exposed stocks. The deepening political crisis triggered a fresh wave of selling as passengers calculated the potential cost of a cliff-edge Brexit – or a Jeremy Corbyn-led Labour government – and threw investments overboard.
Investors are now anxiously scanning the horizon for a haven. Bond funds have traditionally been seen as the calm port to aim for. But with the Bank of England pulling away from quantitative easing and interest rates headed higher, they are not providing the traditional protection. So which ports to seek as the storm rages?
Even before the stormy seas of the past week, retail investors had already thrown overboard some £10.5 billion from UK equity funds since the EU referendum.
UK investors have traditionally favoured domestically focused funds. These topped the sales charts in the year leading up to the EU referendum. But there have since been heavy outflows – £1 billion withdrawn in the month of the vote and a steady flow of redemptions since.
Latest figures from the Investment Association show UK equity funds again at the bottom of the sales charts, with £329 million withdrawn in September. And the sell-off over the past six weeks will have added much more to this total.
Among the funds hardest hit have been the previously top-rated Woodford Equity Income fund. Outflows here since the Brexit vote have totalled £3.2 billion, shrinking this previously popular fund from £10.2 billion to £5.6 billion.
Outflows from Invesco Income fund since Brexit are at £2.8 billion, with the group’s high income fund losing £1.9 billion. AXA Framlington UK Select Opportunities, another well-regarded fund, has had outflows of £2 billion.
Brave souls will see this as a buying opportunity. But with market volatility on the rise, the UK economy already losing momentum and fears of a recession next year if the Brexit crisis drags on, many passengers simply do not have the stomach to help themselves from the UK equity fund table d’hote.
“Head for fixed income and bond funds” has been the advice from seasoned sailors. But as David Jane, manager of the £554 million LF Milton Cautious Multi-asset fund and two similar defensive funds points out, bond yields rose during the sell-off, with the result that “bonds’ promise of inverse correlation isn’t bearing fruit”.
As if this was not enough, he told Trustnet last week that bond yields look set to continue rising in the near term thanks to the US Federal Reserve’s commitment to hiking interest rates and the European Central Bank’s planned withdrawal of QE. Jane says: “The historic purpose of bonds was as a low-risk income-generating diversifier, which performed well when equities were weak. This appears to be no longer the case. Most scenarios that are negative for equities are also negative for bonds.”
Furthermore, the economy now has high levels of corporate debt, built up during more optimistic times with ultra-low interest rates. While the average company is likely to find its debt servicing costs manageable even with expected rate rises, Jane points out that there are still plenty of “zombie companies” already struggling to service their debt. Given this scenario, investors would be less willing to lend to business such as these.
Time, then, to diversify elsewhere, but into what? One area the Miton multi-asset teams are looking at is lowly-indebted infrastructure equities, particularly those active in less economically sensitive areas. The funds have exposure to airports, railroads, pipelines and telecommunication networks. This area is not without risk. But it tends to display lower volatility than equities and often grows revenues close to nominal GDP, giving some protection against rising interest rates.
In addition, the team has been building a modest position in real estate investment trusts (REITS), while exposure to gold has been increased as a risk-off inflation hedge.
However, I suspect that for most of the queasy passengers struggling to stay upright on HMS Brexit, building up deposit accounts or cash ISAS in a well-bolted treasure chest will be the preferred option as the storm rages.