Brexit – A case study

Following a market ‘shock’ we are often asked the question “So what has QSuper done?” Over the next few days using Brexit as a case study we will provide you with insights as to how we deal with such events. Today’s article will focus on how we consider the possibility of such events occurring in the context of the broader investment strategy. Tomorrow’s article will talk to the shorter term tactics applied and portfolio moves¹ transacted. The final post on Friday will profile the risk management activities undertaken daily by our capital markets desk to rebalance asset and currency positions and to ensure that appropriate levels of liquidity are maintained. We trust you will appreciate the additional insight these articles provide in considering the above question.

First and foremost it is important to recognise that strategy is set over the long term with shorter term tactical positioning framed within that context. For several years we have been positioning portfolios to cope with a range of scenarios. While our central position has been that there will be a slow recovery, we have also flagged that the risks around this position are unusually skewed toward possible disappointment.

The world is still recovering from the global financial crisis of 2007-8. Unemployment is still elevated globally, and even in the US where headline unemployment is low, part-time employment is elevated.  This means there is considerable scope for growth to continue to recover.  Ours and most commentators’ central position is that growth recovers to more normal levels, albeit that those growth rates are lower than pre GFC levels due to changes in age demographics.  However this relatively positive central position is challenged by a range of concerns.

Cumulative short term measures (such as fiscal and monetary stimulus) before and since the GFC have seen a lot of economic activity brought forward.  For example buildings and factories that would not otherwise have been built are already in place. The overcapacity that has resulted as a consequence of past stimulus makes it harder for business to invest today.

Governments globally have reduced ability to influence/lead their electorates in sensible, rational ways. Partly because they are uncertain as to how given the unprecedented conditions prevailing, partly because they are still choosing short-term actions over long‑term fixes.  As the world is doing it tougher, this leads to protectionism and nationalism, which is seen as less efficient for global wealth and wellbeing (economically, politically and socially).

The range of policy responses (monetary and fiscal) available to stimulate economic activity post-GFC have largely been applied. Such policy responses are now less effective in addressing unexpected shocks, and it is more difficult to confidently model the likely impact of future shocks. Global interest rates are lower than they have been in recorded history, with a number of major economies experiencing negative yields.

There will always be short‑term geo-political shocks.  We and others are not able to accurately forecast them, or reactions to them. The unexpected vote to Brexit is one of these types of shorter‑term geo-political shocks. Whilst acknowledging it was possible, both in our assessment of the risk and the positioning of the portfolios, we like most, did not specifically forecast that happening

Given the strategic backdrop outlined above, the market, economic and political reactions are going to be bigger, longer and less predictable to these kinds of events than they have been in the past.  Risks are simply higher, government reactions are less predictable and even if policy makers want to react in traditional ways their ability to do so is severely limited.

Accordingly, we position our diversified portfolios² this way:

• Diversify widely among asset class and factors that impact returns in a big way (countries, sectors, interest rates etc.).
• Resist the temptation to put too much confidence in our central position of where markets are headed. Rather than believing that this central position will be right and concentrating the portfolio accordingly, we aim to position the portfolios to be robust to the range of outcomes that we know could occur. In practical terms we do not concentrate into anything.
• We accept that in some scenarios this may limit returns but that in most scenarios it provides a good balance of return‑seeking and risk management relative to the investment objective targeted.
• This is a reasonably simple philosophy. The challenge is to know exactly what to do each day and how to strike this balance as events unfold over the long and short term.

Which brings us to the topic of tomorrow’s article “Short term Tactics: Our response to Brexit”.

1. Noting that risk is dynamically managed through changes made to asset class allocations and therefore the effect of such moves will impact differently depending on the asset profile of the individual option/s you are invested in.

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.