Investment Report for June 2016

OVERVIEW

June was the most exciting month in the markets for many years due to the decision by the UK to do a “Brexit”.

The uncertainty in the run up to the EU referendum and the Leave vote have dominated market movements over the month. Markets were priced for the UK to remain within the EU and the result came as a shock.

The shock immediately manifested itself in the value of Sterling which fell precipitously on the morning of the result. However, the translation effect of significantly weaker Sterling (which boosts overseas earnings from shares) meant that globally diversified portfolios held up well through market volatility. This highlights the importance of investing in a well-managed diverse portfolio.

The large movement in the relative value of Sterling meant that UK equities performed less well than Overseas equities. Fixed Interest performed well as investors sought safer assets through the uncertainty.

As is usual, undue emphasis has been placed on the value of the FT100 share index, which after an initial sell-off has climbed significantly. This reflects the fact that 2/3rds of the earnings made by the constituents of this index are derived in Dollars or Euros and other foreign currencies. Many more UK focussed companies that earn their revenues directly from the UK suffered severe falls.

An effect of the referendum which has been well publicised is that property funds have suffered large outflows after the referendum. This led investment managers to enforce downward revisions to their fair value and even suspension of dealing. Therefore, Property has been the worst performing asset class.

The attractive income yields on offer may entice investors back to the asset class in the ongoing “hunt for yield”. This is a fluid situation which we have monitored closely, preferring initially to exit the market where this was possible and subsequently to remain invested, once the terms on offer in the event of a sale trade became unattractive.

We enclose a table demonstrating the performance of various indices and benchmarks over the month and other time periods for comparison.

This data needs handling with care; the indices do not include reinvested dividends and with the exception of the FT World Index are not translated into Sterling. We’ve highlighted the one-month figure of the world index so you can see how well this has done, simply because of the weakness of the Pound. In reality most global markets were flat (eg the S&P 500 in the US) or fell over the month.

Here is the chart of the FTSE 100 index for the last six months:

…and the last five years, which puts this into perspective;

FUND PERFORMANCE

We enclose tables showing the performance of the portfolios over various time periods to the end of June;

Short-term Performance

Long-term Performance

(Source; Parmenion Capital Partners LLP)

PORTFOLIO REVIEW

All Portfolios

All portfolios were pretty flat in June after a hugely volatile month. There were large movements in many of the underlying investment funds both up and down which largely cancelled each other out.

Our attempt to neutralise portfolios to the impact of a possible Brexit was partly successful. The overseas investments and bonds we hold helped offset the weakness in parts of the UK market and in the UK commercial property market. However, the Income and Balanced portfolios still had exposure to commercial property and this dented relative returns over the month.

Income Portfolio

The Income Portfolio fell by -0.5% in June under-performing the benchmark (the average mixed investment (20-60% shares) fund) which gained +1.4%.

Our exposure to UK commercial property dented returns.

We sold some commercial property immediately after the referendum result was known getting out at a reasonable price.

Balanced Portfolio

The Balanced Portfolio gained +0.2% in June, under-performing the benchmark (the average mixed investment (40-80% shares) fund) which gained +1.7%.

Our exposure to UK commercial property held us back over the month.

We sold some commercial property immediately after the referendum result was known getting out at a reasonable price.

Tactical Portfolio

The Tactical Portfolio gained +0.2% in June, under-performing the benchmark (the average Flexible fund) which gained +2.4%. The portfolio’s heavy exposure to UK smaller companies detracted from performance. However, the portfolio has had no exposure to commercial property.

We did purchase a European property fund last month as a diversification and this gained in value over the month.

OUTLOOK

The UK has voted to leave the European Union. As the initial reaction in financial markets has shown, there is no merit in pretending that for investors and companies this is not, by some margin, the worst of the two possible outcomes of the referendum.

We had expected the result of the vote to be close, but our view was nevertheless that the status quo would prevail. In spite of our views we had planned for either outcome by carefully balancing UK equities with overseas equities. However, we failed to anticipate the speed with which a Brexit outcome would impact on UK commercial property.

The biggest sadness is that it is reasonable to assume that the UK will quickly enter a period of economic recession, or at best stagnation. This is largely caused by the uncertainty that Brexit has created for business, industry and the world of finance. The IMF published figures this week that fortunately indicate more of a slow-down than recession, which is cheery news.

It is difficult to say at this stage what action the Bank of England may take, but it is not impossible to imagine that it may quickly cut interest rates. Restarting the programme of quantitative easing – a feature that has been absent from the economic landscape for some three years now – also looks a possibility. At the very least, the central bank has indicated its preparedness to take such action.

We believe that the prospects for domestically focused UK businesses are clearly the least attractive. FTSE multinationals will, on a relative basis, almost certainly perform better than their domestically oriented peers as the weaker pound will support overseas earnings when translated back into sterling. We will probably be buyers of this type of business via FTSE tracker funds.

Excellent income yields are also available now in the UK market.

In terms of international markets, there seems to be a real possibility that the result could contribute to a complete breakup of the EU. It’s noticeable that our own stock market has performed better than the main European markets since the referendum. Investing in Europe has become less attractive as it must involve higher risk.

Looking further ahead, it seems inevitable that the UK and European economies will face a period of two to three years of uncertainty, as the UK attempts to negotiate how to extricate itself from the European Union, while maintaining access to European markets and the EU has to deal with more potential Exiteers. There is however, always the possibility of reform.

The general climate of uncertainty makes investment decision very difficult – so we probably won’t be making any in the short term and will leave portfolios much as they are with a very broad spread of investments.

The UK commercial property market is exceedingly difficult to call. The value of commercial properties is linked to the strength of the domestic economy. If the economy is weak prices will fall. However, there are some positives;

• Sterling weakness makes UK properties cheaper for overseas buyers, compared with alternatives. UK Property is now trading at a 10%+ discount for overseas buyers due to currency movements.
• Property still produces excellent yields and these are relatively more attractive than previously as the yield on alternative asset classes has dropped.
• The overall economic impact on the UK economy, although not a good thing, may not be as bad as feared.
• A US vulture fund has been established to buy distressed UK property – so buyers are in the market.

Anecdotally, one large property was sold in London last week that had been in negotiations before Brexit. However, the price achieved was not known.

The upshot is that we are likely to stick with the reduced property investments that we have and will decide what further action to take once the direction of travel is known.

More further afield its notable that the emerging markets are starting to move ahead. We increased exposure in the spring and hope that this will boost performance.

PS Don’t forget the usual risk warning for all long-term investments: “The value of units can fall as well as rise, and past performance is no guarantee of future performance. The value of income payments from investment funds is not guaranteed and can fall as well as rise”.