The United Kingdom’s exit from the European Union will take years to play out, but impacts to the currency and the global capital markets have been immediate. We are seeing the classic “sell before asking” behaviour play out in the markets.
We do not believe Brexit to be a black swan event. While it was considered less probable, it was still a live possibility. A 10% correction in the broad equity markets is not unreasonable given the outcome of the referendum and it will bring us to fair valuation levels.
While global stocks are selling off aggressively, there are pockets that are doing extremely well, such as US Treasuries, the US dollar, the Yen and gold. We have not attempted to call for an exit or remain. In line with our process, we have positioned our portfolios based on long term fundamentals and valuations. News does change valuations and we react to that. In advance of the referendum, we had been selling Sterling, buying bonds and the US dollar and trimming equity.
Our objective in this environment is to harvest opportunities from market inefficiencies and take advantage of extreme pessimism.
We have been favouring “out of favour” asset classes such as the U.S. dollar and long term sovereign bonds. As Brexit has effectively unlocked some of the value in these asset classes, we are taking some profits but still have meaningful positions as they are attractive in this environment. In the CI Select Income Managed Fund, bond duration is at 5 years (down from 5.5 two weeks ago) and we are overweight the long end of the yield curve. We own 30% U.S. dollar exposure. We have kept equity at a low level of 12% and have room to add. Across all of our more income-oriented portfolios, we are delivering low volatility in a highly volatile environment for our most conservative investors.
We also favour U.S. dollars and sovereign bonds. The equity weighting has been lowered consistently over the last 12 months due to market valuations; this was not a call on Brexit. Some short-term downside volatility is expected but we are confident that we will achieve attractive returns for the clients’ investment horizon, which is typically five to seven years. We have the ability to bargain hunt in these portfolios while remaining within our risk budgets. We will likely sell some bonds as they have gone from being “out of favour” to “in favour”.
These portfolios typically invest the majority of assets in stocks for the highest long-term growth potential. Declines in the stock markets will have a larger impact on these portfolios. However, given the long investment horizon, short-term events are unlikely to leave a permanent effect on long term returns. Valuations will normalize over time. Our ability to reposition the portfolios provides opportunities to enhance long term returns for our growth-oriented investors.