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In the aftermath...

I was shocked this morning at the outcome of yesterday’s Referendum; however, we have now been dealt our poker hand and it’s our job to play that hand to the very best of our ability as the game unfolds.

Here is a short summary so far, we see things developing in three distinct stages over the coming months and years. I hope things stop at stage one; however, there is every possibility that we slowly progress to stage three as events unfold.

Stage 1

A surge in volatility in currency and equity markets worldwide, creating both winners and losers. This has clearly already happened.

Stage 2

The UK enters a recession (which is defined as two negative quarters of GDP growth). We think this is very likely to happen due to the combination of increased prices (imports are now significantly more expensive), businesses holding back on spending/ hiring, deferring decisions and businesses/ jobs leaving the UK or not coming here as planned.

This will lead to an abundance of negative media headlines, further eroding confidence and perpetuating the problem. The outcome is likely to be even more volatility and falls in markets either selectively or across the board.

Stage 3

The political unrest already evident throughout the world leads to, at best, governments that you would not describe as business friendly coming into power or, at worst, the break-up of the EU. We will of course also need to revisit the Scotland issue and then add Northern Ireland and even Gibraltar onto the agenda. It looks likely that the Referendum could be the start of something much bigger.

This could lead to a global recession which policymakers and central bankers could struggle to fight given the level of current interest rates and QE already deployed. In short, they could quite simply be out of ammunition.

It is possible (however remote) that this could give rise to market turmoil, similar in scale to that experienced during the credit crunch.

Implementing the plan

As you would expect, we have given the issue a great deal of thought and debated all the options that are open to us. We feel that, given the outlook described above which might take many years to unfold, being cautious and creating liquidity is the most sensible way to protect your portfolios, ensure you can continue to withdraw income without the need to sell anything and, of course, to take advantage of opportunities as they arise.

You may have read that last week we sold a portion of UK equity, property and fixed interest to take tactical cash in a Balanced portfolio up to 12% (14% including the standard 2% cash reserve).  This ensures that for any clients taking income, there is no need to sell assets which could potentially be at a loss for many years to come.

In addition, we have today placed trades to hopefully sell ALL of our property holdings which equates to 12% for a Balanced portfolio and then initially invest this in cash. The reason for this is threefold:-

1. Property funds were experiencing outflows of money even before today’s result. If outflows now pick up it is possible that they could invoke the clause that allows them to shut the doors and enforce a notice period (typically a year) before we could access the cash. We want to get our clients’ money out before this happens and “hopefully” the trades will go through due to our prompt action.

2. We already think that there are reinvestment opportunities available and so we would like to use circa 3% of this money to buy an index linked gilt fund as we feel that inflation is likely to pick up due to the drop in sterling making imported goods more expensive. We would also use a further 3% to buy alternative equity which we hope can still make money in all market conditions.

3. We believe that there will be many more opportunities to invest in other assets at some point in the future at much lower prices than we have sold them for. 

Are we overreacting? 

We don’t think so. If markets stabilise and the outlook becomes clearer, we can switch back in as quickly as we have switched out and we believe that the likelihood is that we will be able to do so at lower prices. We will be looking constantly for opportunities whilst at the same time making sure that we don’t act prematurely. At worst, we could sacrifice some upside; however, we feel that this is an acceptable risk at the current time.

We are still positive 

We hope that portfolios will hold up well and whilst we may have to endure some short term losses, that over the medium term we can still achieve some decent returns by buying the right asset at the right time, at the right price. Whilst the credit crunch was painful, portfolios were still positive over 5 year periods and given today’s cash rates, I certainly expect that we will significantly outperform cash over the next 5 years.

More to come

We will continue to issue briefings to keep you informed of our thoughts and actions. If you have any specific questions that you would like to ask, or topics that you would like us to cover, then please contact us at askus@eqllp.co.uk