In my usual round of conversations with fund managers and investors, the possible implications for markets of a ‘Brexit’ have understandably featured large. My response has surprised a few: there should be no effect; any actual effect is likely to be already priced in and therefore marginal, if at all; and it’s a storm in a teacup compared with the much more fundamental issues. The market will certainly move on whatever the result.
Dogs bark when elephants walk by
The increasingly absurd claims of ‘Project Fear’ reveal the weakness of the Remain camp’s argument and deserve ridicule – suggestions of war will no doubt be followed by plague and pestilence! A calm assessment of the facts reveals a different story.
The UK runs a massive trade deficit with EU countries exceeding £65bn a year – it is in their interest for trade to continue. On exit, and before any change to the trading status quo, the Lisbon Treaty allows a two-year window to negotiate a mutually acceptable settlement as part of the leaving process – this would, in all likelihood, include a trade deal.
But we should remember that trade is not dependent on trade deals – as our many purchases of Chinese products illustrate. Countries from around the world, many much smaller than ours, trade profitably with the EU – some have trade deals, and some not. Even without a trade deal, both the UK and EU would be bound by the World Trade Organisation’s ‘most favoured nation’ tariffs paid by other nations – the US’s average tariff is currently around 3 per cent. Even if wanted, punitive tariffs could not be imposed.
We should also not forget that those peddling ‘Project fear’ are broadly the same group who predicted doom if we left the ERM and then disaster if we did not join the euro – they were wrong then, and they are wrong now. The EU remains stuck in the global economic slow lane with high unemployment rates to match. There could be many economic advantages to us leaving.
The UK’s economy compares well but would do even better if it were free from the shackles of EU business regulation – only 5 per cent of businesses trade with the EU and yet 100 per cent are bound by its regulations. Even if Remain is right and the pound depreciates on exit, this would help exporters in the short term, while the UK’s newfound ability to negotiate its own trade deals without going through the tortuous EU bureaucracy and special interest lobbies could also help long-term growth rates.
Furthermore, as admitted by Lord Rose, the leader of Remain, by better controlling immigration for the benefit of our public services, wages would rise faster. And the freedom to introduce a ‘fairer’ immigration policy, one that does not discriminate against the rest of the world, would better attract the talent of the world for the benefit of all.
Trade would continue with Europe as it always has, and relations would possibly improve as the sceptical Brits would no longer be a thorn in the side of an EU intent on pursuing monetary, fiscal and political union.
No, the market knows there are bigger questions – much bigger. Will central bank policies once considered radical – persistently low interest rates, quantitative easing, negative interest rates – succeed in stimulating growth, or will governments have to intervene more directly? And what effect will such policies have on a still weakened financial system?
At what cost capitalism’s present obsession with the short term and the consequent lack of investment, when the future will belong to those who invest for the long term even if this entails greater volatility? And how quickly will the corporate ‘dinosaurs’ make way for their more nimble successors?
These are just some of the elephants quietly on the move – ‘Brexit’ is nothing more than a dog barking from the sidelines.
The bigger picture
But even here, we need as investors to keep things in perspective. By focusing on these bigger questions, we risk missing the bigger picture – particularly given the ‘noise’ regarding interest rates and growth. As equity investors, we must remain focused on the most important issue of all – the ability of companies to create value and wealth.
And here, as regular readers will know, I continue to believe the future is small. Because of technology, the costs of entering a market and growing market share have fallen significantly. This will leave fewer and fewer established citadels impervious to assault – particularly from those willing to invest. Smaller companies will disproportionately benefit.
And within this universe, a growing number will not be listed. Armed with their newfound cost advantage, and seeking less funding via markets focused on short-term returns, these managements are taking a longer-term view both in terms of investment and their desire to go public. For reasons highlighted in a recent column (‘Seeking value via private equity’, 8 April 2016), investors need to be positioned accordingly.
Portfolio changes
After no activity in April, May proved to be an unusually busy month for both portfolios.
Within the Growth portfolio, I continued to build exposure to smaller companies. Accordingly, during May, I sold entirely the portfolio’s holdings in JPMorgan Japanese (JFJ), JPMorgan European Income (JETI) and Perpetual Income & Growth (PLI) – all good trusts, mostly held in other portfolios, but here I prefer to focus on smaller companies.
With monies raised, I introduced Small Companies Dividend Trust (SDV) while on a 10 per cent discount and offering a 4 per cent yield. I also added to existing holdings of JPMorgan Japan Smaller Companies (JPS), Aberforth Geared Income (AGIT) and Oryx International Growth Fund (OIG) while standing on discounts of 15 per cent, 10 per cent and 17 per cent respectively – short-term timing proving fortuitous in some cases, as visitors to my website will know.
Within the Income portfolio, during May I nuanced the smaller company exposure. I sold entirely Henderson Smaller Companies (HSL) with its strong mid-cap bias and added to Acorn Income Fund (AIF) which focuses on generating income from smaller companies – bought when standing on a near 10 per cent discount and offering a yield of 4.5 per cent.
In addition, I replaced both Herald (HRI) and International Biotechnology Trust (IBT) with F&C Private Equity (FPEO) when offering a 4.5 per cent yield and being cum-dividend. While happy to retain HRI and IBT (and HSL) elsewhere, FPEO offers exposure to both early-stage technology and biotechnology.
I will explain in more detail the attractions of both SDV and FPEO in next month’s column.
