DIY Investor Magazine
/
July 2016
30
Brexit – a Curious Political Situation
Neil Hermon, Henderson Smaller
Companies Investment Trust
The surprise ‘leave’ result following the UK referendum
on EU membership was a shock to markets, which were
to an extent wrong-footed by exit polls and bookies’
odds strongly in favour of a ‘remain’ outcome. The
binary nature of the referendum has meant that a sharp
movement upwards or downwards was always to be
expected.
IThe bigger shock to markets has been the curious
political situation the UK finds itself in which seems to
suggest the result took the government and key players
of the ‘Vote Leave’ campaign by surprise too. At the
time of writing, the Prime Minister has resigned, the
front-runner to succeed him has pulled out of the race
and Labour MPs overwhelmingly voted in favour of a
vote of no confidence in their leader.
As a consequence, there is no clear picture developing
around how our relationship with Europe will proceed
going forward. The risk is that political instability will
breed uncertainty and hurt corporate and consumer
confidence. At this early stage, the impact on the
economy remains to be seen, and we expect little
clarity until economic data is released at the end of
July. However, lower levels of activity in the summer will
likely serve to distort the true picture, so corporates and
investors may be flying blind for quite some time.
Putting things in context: with world banks’ share prices
falling 11% in the two days following the referendum
vote - considerably more than following the collapse
of Lehman’s brothers – some commentators are trying
to draw comparisons to the global financial crisis. We
would discourage from drawing such parallels and
believe that this is a localised issue.
The Governor of the Bank of England has reassured
markets that a plan is in place to provide liquidity and
support and has also directly stated that UK banks are
better capitalised and therefore equipped to deal with any
future shocks. Encouragingly credit markets have held up
relatively well in comparison to the global financial crisis,
as illustrated by the credit default swaps (CDS) market
where the cost of insuring loses against bonds hasn’t
become materially more expensive. Furthermore, the
muted reaction of North American CDS market support
our view that this issue is contained to the UK and Europe,
at least for the time being.
UK Equities have been mixed. At time of writing the FTSE
100 is up +3.81% since the eve of 23 June 2016, while the
FTSE 250 index is down -4.92% and the Numis Smaller
Companies ex. Investment Trusts Index (the benchmark of
Henderson Smaller Companies Investment Trust) is down
-5.9%. The divergence in fortunes is reflective of the fact
that the FTSE 100 is a large cap international index whilst
the FTSE 250 and Numis Smaller Companies index better
reflects the UK economy and includes more UK domestic
stocks.
In the months leading into the referendum vote,
trading and new investments in the Henderson Smaller
Companies Trust were focused on long-term, structural
growth stories where the investment case did not rely
on what was going on with the broader macroeconomic
environment. However, the domestic bias of our portfolio
did not leave us immune to the Brexit aftermath. Our
response has been to reduce the Trust’s gearing
(borrowings), primarily through the judicious sale of UK
domestic stocks.
For instance, the extreme mark down of UK housebuilding
stocks feels inconsistent with the underlying investment
case: they have strong balance sheets, there’s a lack of
housing supply nationwide, the government is broadly
supportive and the banking sector looks healthy; we
have retained these positions and will continue to focus
on stock picking to exploit the opportunities Brexit has
presented us with.
Nothing in this document is intended to or should be construed as advice and you should satisfy yourself as to its suitability and the risks involved,
you may wish to consult a financial adviser. This document is not a recommendation to sell or purchase any investment. It does not form part of
any contract for the sale or purchase of any investment.Issued in the UK by Henderson Investment Funds Limited (reg. no. 2678531), incorporated
and registered in England and Wales with registered office at 201 Bishopsgate, London EC2M 3AE, is authorised and regulated by the Financial
Conduct Authority to provide investment products and services.
