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July 15, 2016

U.K. Domiciled Mutual Fund Volatility Normalizing Post “Brexit” Vote

by Jake Moeller.

The short-term volatility of U.K. domiciled mutual funds is beginning to normalize after peaking in the aftermath of the “Brexit” result of the U.K.’s European Union referendum on June 24, 2016.

The featured graph (above) shows the daily rolling ten-day volatility of funds in the Lipper Global Fund Classifications, popular in the U.K., going back one year. The short-term volatility spike evident post “Brexit”- vote can be seen clearly across most sectors, but it has been most marked in the U.S. and U.K. equities classifications.

A similar spike in short-term fund volatility was seen in the aftermath of the China “wobble” in summer 2015, but for U.K.-based funds, it was contained largely in those exposed to U.S. equities and high-yield credit markets.

Another significant difference in these two major spikes was the dramatic increase in the volatility of U.K. government bond funds. These funds barely registered any increase in volatility over last summer but more than doubled in the week following the Brexit outcome, incorporating the huge effect of the sudden devaluation in Sterling and increased risk aversion.

Risk aversion and fund flows

Risk aversion has also been reflected in shorter term fund flows, with our Eikon fund flow analysis revealing an estimated net outflow of US$ 4.2 billion from U.K. funds in the month of June. The flows heat map shows outflows have also affected Europe (with the exception of Germany) more generally and displays a large monthly rotation of some US$ 24 billion into money market funds by investors (see Figure 1. below).

Fund outflows in the aftermath of the Brexit vote have not been a homogeneous experience for all U.K. fund groups. In a recent Lipper interview, Kames Capital’s Director of Wholesale, Steve Kenny stated that while “all fund groups are worried about what the next six months mean for flows and redemptions”, product offerings are now more significant (Kames has a strong Dublin-based branch to its business).

Exhibit 1. Eikon Fund Flows Map (one month to June 2016)

Source: Eikon

This is a view reflected by Clive Selman, Head of U.K. Wholesale at Hermes Investment Management. “Fund flows have remained net positive for us prior to the referendum and post” states Mr Selman. “The nature of the downside-protection element of our fund range has been helpful, as well as having funds in sectors that look relatively attractive – GEMS, Asia, and U.S. SMID”.

Buoyancy in the U.K. Stock Market

This risk aversion and spike in fund volatility have come about despite what some analysts see as a surprisingly buoyant U.K. share market. Head of Equities at Hermes Investment Management, Andrew Parry, believes part of the reason for the relatively benign outcome post-Brexit is that most investors were positioned bearishly ahead of the vote. “High cash levels, reduced equities exposure, and large open put options provided strong technical support,” states Mr Parry. “Such pessimism was not based on politics alone – the consensus view was that the U.K. would vote to remain in the EU – but fears of slowing global growth.”

Exhibit 2. FTSE All Share Performance Year to Date (July 14, 2016)

Source: Eikon

As U.K. fund volatility appears to normalize, Mr Parry is commensurately sanguine about support for the U.K. equity market in the medium-term. “The reaction of monetary authorities, who have learned from previous crises, provided liquidity to markets and promised more policy action to come,” he says. “The need for investors to earn a profit also contributed: with US$13 trillion of government bonds globally providing negative yields, the hunt for attractive returns will continue.”

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