Thursday, 30 June 2016

In this, the second of our Brexit articles we focus on the shorter‑term tactics informing our response to the UK voting to leave the European Union (EU). Right up front we should be clear that our long­‑term strategy dominates and that tactical positioning will not override the strategy; it will not turn a significant negative into a positive for example.  However we do believe that observing markets and managing risk can make a significant difference to members’ risk and return outcomes.

QSuper is always growing and because of that we’re constantly investing money. This means we have the ability to shift our investment exposures around in a limited way in the short‑term. In the lead up to the Brexit vote, polls suggested that the outcome could be close. Our initial view, in line with most of the market, was that it would be unlikely the UK would vote to leave the EU due to the resulting economic challenges and uncertainty that would result from a leave vote. However, when we looked at markets there appeared to be an inconsistency between polling and what was priced in these markets. 

If the United Kingdom left the EU, forecasts were that it would experience a significant recession.  However UK equities had broadly tracked in line with other international equity markets. Hence the potential market reaction seemed skewed; small gains if the ‘remain’ won but a significant selloff if ‘leave’ won. 

At this point, due to the apparent inconsistency between pricing and risk we decided it made sense to reduce our exposure to UK equities; this was reduced from 14% to 8% of the international equities portfolio in early June.  To be clear if the vote had been to remain it’s likely that UK equities would have outperformed a global index in which case we would have seen a slight negative in performance.  This reflects the trade-off that we view as a wise one – taking on a small chance of underperformance (in a positive event) for a large chance of outperformance (in a negative event). 

When it was clear that the ‘leave’ vote would win, markets experienced significant volatility. The wide gyrations that occurred as markets scrambled to reset on Friday, saw prices move to levels where QSuper saw value in opportunistically trading in both International Equities and Fixed Interest (our Dynamic Asset Allocation1 (DAA) process - see tomorrow’s article for further detail). 

Turning to unlisted assets we have some very material exposures to UK and European assets and we (together with our specialist managers) have been closely managing them.

Here is our assessment of these assets:

  • Infrastructure:  These assets provide essential services to communities and are needed regardless of whether or not the UK is part of the EU and we don’t expect that the British vote to leave the EU will have a material impact on them.
  • Real Estate: These assets tend to be more impacted by the economic cycle. We have used recent market strength to sell a number of assets in UK/Europe given the heightened risks associated with the macro environment and Brexit. The remaining UK assets are expected to display relatively lower risk reflecting their length of lease, tenant quality and/or dominant position. 
  • Private Equity: Our investment manager has been cautious of the broader macroeconomic environment over the past 12 - 18 months.  As a result, QSuper’s exposure to private equity has deliberately been deployed at a slower pace than target.
  • Financial instruments are used to protect the impact of movements in currency.

Going forward no one can be sure what will occur. However we do know that our diversified portfolios2 are robust to the range of potential outcomes. We’ll continue to monitor market risks and pricing, and seek to manage these risks and add value when risk and pricing doesn’t align.  As noted earlier, this may supplement, but will not dominate, the strategic settings of the diversified portfolios.

Tomorrow we’ll profile the risk management activities undertaken daily by our capital markets team to implement DAA decisions, rebalance asset and currency positions and ensure appropriate levels of liquidity are maintained.

1. DAA recognises that from time-to-time, asset valuations can move away from economic fundamentals. With a belief that economic fundamentals drive asset prices in the long-run, these deviations can be used to adjust asset allocations to take advantage of these moves away from fair value.

2. Diversified portfolios references QSuper’s multi-asset class Ready Made and Lifetime Options.

The views of the author and those who provide the responses to comments posted on this blog are not necessarily the views of the QSuper Board. We’ve put this information together as general information only and you should get professional advice before relying on this information.

Past performance is not a reliable indicator of future performance. Each of our investment options has a different objective, risk profile, and asset allocation.