How we stand today
It’s been a very eventful 6 months for financial markets, culminating in the fall-out from the result of the “Brexit” referendum in the UK. Volatility in financial markets, including currencies, spiked on the result and sentiment remains fragile.
Markets took some re-assurance in the view that Central Banks would step up their efforts to support growth in the face of this new threat, and that while it might be bad for the UK, the rest of the world can cope.
Apart from a likely recession in the UK, a key risk is financial contagion from the UK to the Eurozone, fuelling more populist pressures, and if we were to see more knife-edge votes, it would impact on Eurozone markets overall.
Policy and politics are key drivers in the near term and the leadership vacuum in the UK may persist for several months. Indeed the invocation of Article 50 in the UK, the necessary step to begin the process, appears to be pushed back even further.
Brexit does represent a negative shock to a global economy where growth is resilient but not that robust. It seems central banks will remain very supportive. The Bank of England and the ECB look like they will remain in easing mode and the Federal Reserve in the US may hold off on rate hikes as it takes account of the health of the global economy in its decision making process. In the near term we are likely to see a wave of downward revisions to corporate profits and economic growth as the full impact of postponed investment plans, relocation, volatile property prices and weaker consumer confidence is assessed.
We believe markets will ebb and flow as we get greater clarity around the process and as companies firm up on strategies to manage their way through this uncertainty.
How are we positioned?
Brexit was one of a number of risks that we identified at the turn of the year, along with a debt-laden Chinese economy, European instability and US politics. It’s fair to say we can’t close the file on any of these.
Because of these “event” risks and the back drop of a sluggish global economy, we had been building up the cash levels in our funds over the past 12 months. Today, for example, our allocation to cash is in excess of 30% in our Value Funds.
We have also built up (and will continue to) our allocation to assets such as forestry, property and infrastructure, which offer real growth and diversification.
Our equity portfolios have a solid back bone of strong balance sheets, superior return on capital, good free cash flow and sustainable dividend yield. This discipline ensured we had modest exposure to banks and none at all to UK banks which bore the brunt of the market downturn.
Our asset allocation and our quality bias meant that, in spite of all the market and currency volatility, the Appian Value Fund registered a decline of just over 2% in the first half of the year, and was essentially flat (-0.09%) for the second quarter.
While we are cautious, we are not pessimistic, and on weak days in the markets we are ready to pick- up stocks where we see value in indiscriminate markets.