July 4, 2016

Monday Morning Memo: Brexit and the CIO

by Jake Moeller.

Jake Moeller discusses the “Brexit” fallout with the CIO of Kames Capital–Stephen Jones, and its Director of Wholesale–Steve Kenny, on June 30, 2016.

As a Scotland-based firm in the U.K. and owned by Aegon, a European-based multi-national insurance company, Kames Capital is an asset management business with multiple touch points on the rapidly developing Brexit saga. It currently has some £57.8 billion (€77.0 billion) of assets under management, with distribution across the U.K., Austria, Germany, France, Belgium, Italy, Luxembourg, Netherlands, Spain, Switzerland, Sweden, and the Channel Islands.

Stephen Jones, CIO - Kames Capital. With permission.

Stephen Jones, CIO – Kames Capital. With permission.

Despite the myriad eventualities that could affect a business such as Kames, CIO Stephen Jones is, strikingly, very calm amid the nonstop news flow that has been generated since June 24.

On Sterling

“We have said all along that sterling would be the whipping boy in this outcome, and we maintain this to be the case going forward,” states Mr. Jones. He cites not only the new degree of disruption from the vote but emphasizes the U.K.’s existing deficit position. “It is clearly an environment for safe-haven currencies,” says Mr. Jones, “and we expect continued sterling weakness against the euro and dollar until the end of the year.” A low sterling also has obvious advantages for companies earning overseas revenue and exporters. “A weaker pound is a tool in managing the U.K. deficit and trying to stimulate activity in the economy,” states Mr. Jones.

Figure 1. One year graph UK Pound Sterling/ US Dollar FX Spot rate (to July 4, 2016)

On Interest Rates

Kames Capital has maintained a “lower for longer” interest rate outlook for some time. In the wake of the vote Mr. Jones has modified this to “lower for yet longer.” He foresees interest rates in the U.K. will move to zero over the summer to pre-empt an abrupt slowdown in discretionary spending by consumers and businesses and to counter headwinds and delays in project activity. He dismisses any possibility of a Bank of England increase surprise to defend sterling because of the deflationary effects of the depreciation. “The BOE has been very consistent in ignoring U.K. inflation and setting monetary policy,” states Mr. Jones. He similarly thinks that negative rates are unlikely. “Government bond yields haven’t spiked, and the U.K. is not an emerging economy. Stimulus is key. There are monetary ways to undertake this, such as specific project funding, before the need for negative rates.”

On the Equity Market

Mr. Jones says there is “nothing particularly exciting” about the Kames view on equities now. “Large-capitalization foreign earners have done well and will continue to do so,” he states. Kames prefers large-caps over the smaller stocks of the FTSE 250 and is sticking to income-oriented names such as Imperial BrandsRoyal Dutch Shell and Shire.

Regionally, he believes that despite its expense, the U.S. offers the best near-term opportunities. “Europe’s fragile recovery wasn’t prepared for Brexit,” states Mr. Jones. “In the U.S. you’ve got full employment, consistency of growth delivery for the last four years, and the Fed also remains on a ‘lower for yet longer’ footing.” He also advocates adding to emerging markets issues. “In a world where developed-market risk premia have gone up, with no great expectation of increased returns, EMs are certainly worth owning (in both equities and fixed income).”

Figure 2. One year graph FTSE 100 Share Price Index (to July 4, 2016) 

Rates and Strategy

Given Kames’ “lower for even longer” mantra, duration continues to be a favored play. “We have added duration in the U.S. market and in long-dated government bonds,” states Mr. Jones. “With continued falls in Asian interest rates and the extension of QE in Europe, then Treasurys are a safe haven and with yield that is a beneficiary of a lot of the turmoil.”

Even if the Federal Reserve increases rates toward the end of the year on the back of strong domestic activity, Mr. Jones isn’t overly concerned and doesn’t see it being more than 1%. “That will have vindicated Yellen (having made two rate increases) but will play to investors wanting to see some more heat in the economy. This will be attractive for credit and high yield as well as equities.”

Mr. Jones is comfortable that the low interest rate has pushed out the default rate cycle and dismisses comparisons that the current market is in any way analogous to that of the global financial crisis. “There has been no distress in cash or securities markets whatsoever,” he states. “You’ve been able to trade any way you want.”

Business Considerations

Director of Wholesale, Steve Kenny, has recently returned from a European meeting of sales peers, where he conceded the mood was immediately “somewhat prejudicial” against U.K.-based companies after the referendum result, but he felt this had dissipated fairly quickly. “All fund groups are worried about what the next six months mean for flows and redemptions,” he states. “We are well placed, but you can’t control buyers’ behavior.”

Mr. Jones sees balance sheet strength as key to dealing with the political uncertainties presented by this vote outcome. “Kames are an independently capitalized, independently governed and regulated entity with a strong and supportive ownership structure. Our capital is dynamically managed and stress tested way beyond any disruption by the removal of the U.K. from Europe or indeed the removal of Scotland from the U.K.,” he states.

Mr. Kenny also points out that having offshore distribution platforms is now advantageous. “Our Dublin-based platform allows us to utilize currency preferences and provide comfort to European clients.” Mr. Jones, however, warns of bottlenecks in the new rush to establish offshore presence. “There is going to be a scramble for offshore centers, but they won’t have increased operational capacity yet, and performance track records will also need to be established.”

Conclusions

Kames Capital is a fund management house with considerable exposure across the whole range of potential Brexit consequences. Yet, it is difficult to perceive any pervading sense of impending doom. Mr. Jones is quick to remind his clients that Brexit is a national and regional concern and will pose many challenges, but that it is not a global crisis. He believes that businesses with broad geographical reach and a diversified product range should not only survive disruption but potentially discover new opportunities.

Mr. Kenny is similarly able to conclude on a positive note: “The average U.K. discretionary fund manager is currently holding double-digit allocations to cash; Europeans even more. With rates so low, it will be a hard allocation to have justified by the end of 2016.”

 

Disclaimer: 
This material is provided for as market commentary and for educational purposes only and does not constitute investment research or advice. Thomson Reuters cannot be held responsible for any direct or incidental loss resulting from applying any of the information provided in this publication or from any other source mentioned. Please consult with a qualified professional for financial advice. 

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