It remains important to focus on specific stocks when investing in UK financials as equities are battered by the Brexit vote, says Portfolio Manager Patrick Lemmens.
His New World Financial Equities fund is overweight on British finance firms excluding banks, although exposure was scaled down ahead of the historic referendum on 23 June, in which Britons narrowly voted to leave the European Union.
The weighting of UK investments held in the fund compared to the benchmark were reduced from 14% at the beginning of June to 10.6% on the day of the referendum, compared to the MSCI All Country Financials Index’s weighting of 7.1%.
“Our overweight in UK financials was not a result of a greater confidence or preference for the UK: it is the result of our investment process, where we look for winners in two of our three identified long-term trends,” Lemmens says.
“In the UK we mainly have investments in the aging finance trend (Aviva, Intermediate Capital Group, LSE, Phoenix Group, Provident Financial, Prudential, River & Mercantile Group, St. James Place), and the digital finance trend (Barclays, Earthport, Paysafe, Safecharge, Worldpay).” The third trend is emerging market financials, which does not apply to the UK.
Lemmens says he is very underweight European and UK banks, which has aided relative performance as their share prices plummeted following the Brexit decision. He says UK banks and other finance companies are likely to suffer as the pound weakens, and if the country enters recession. But perhaps the bigger problem is the years of uncertainty should the UK government invoke the procedure to leave the EU, which means at least two years of divorce proceedings.
“First of all, actually not a lot will change in the way UK and Europe will deal with each other as the exit procedure takes more than two years,” he says. “But economically there will be an impact as the pound has depreciated, investment decisions will be further delayed and potentially aborted, and therefore UK GDP is likely to be hit, potentially causing a recession.”
“That might have an impact on certain financials who conduct business in the UK. For Europe, there may be also be negative consequences to GDP along with the greater political uncertainty. But some countries in which the fund is invested where companies can actually profit from this increased uncertainty. This includes financial companies in Africa and Latin America, the US, Russia, and potentially Scandinavian countries.”
Lemmens says it subsequently makes sense to focus on the three trends, which face short-term wobbles but have a good long-term outlook due to an aging population, increasing digitalization and increasingly prosperous emerging markets.
“For the ageing finance trend we see lower asset valuation levels, continued lower rates in most developed countries and a slower move to higher rates in the US,” he says. “At first, this will make life more difficult for banks, life insurers, asset managers and pension funds. But we also believe that the need to save for later, do financial planning, build your own pension fund and invest in the best risk/return combinations is still very much alive.”
“For the digital finance trend there might be over time a Brexit impact for payment companies. The overall level of payments and transactions may grow less with the UK-European turmoil and pressure on GDP. So we prefer payments companies with a presence in multiple countries and generally have a very diversified global portfolio.”
“For the emerging finance trend, lower global GDP growth and a return of a risk-off sentiment could hurt. However, we are not planning to make significant changes to our investments in the emerging finance trend.”
“Meanwhile, the Brexit aftermath means valuations are lower than ever, and when markets calm down, investors will eventually become more willing to deploy historically elevated cash levels into equities. So we do see any Brexit as an investment opportunity for the longer term, as stocks often overreact in the first couple of days of trading following a shock such as this.”
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