How will Brexit affect key asset classes
AMP Capital's investment teams provide insights into the possible implications on key asset classes.
With Britain having voted narrowly in favour of leaving the European Union (EU) on 24 June, there has been some initial, aggressive price reaction from investment markets. While markets were generally not expecting this result and much uncertainty still remains around the mechanics and detail of the exit, it’s important to consider that markets can overact when presented with increased uncertainty.
This has caused dislocations and heightened volatility in the short term, and also created investment opportunities as some markets become oversold. This all signifies how important it is for SMSFs to carefully consider their portfolio strategy and the medium term opportunities this presents.
Here AMP Capital’s investment teams have provided their insights on the possible implications across some of our key asset classes.
Global fixed income perspective
Simon Warner, Global Head of Fixed Income
Most fixed income markets remain well within their ranges for the year and are flashing orange on the risk of broader economic and market dislocation. Markets have priced in recession for the UK, only.
The Australian economy has only small direct exposure to the UK and the economic impact should be small. There is a risk that the AUD strengthens on the perception that Australia is far removed from the immediate economic fall-out and that its high real rates support currency valuations. If this scenario eventuates the RBA is likely to respond with rate cuts, which were expecting to happen this year anyway.
We will be watching European banks and Italy in particular for the wider impact. The European banking system is still weak and is vulnerable to wider sovereign spreads, wider credit spreads, and lower equity prices. Policy makers have limited room to move if there is spreading contagion.
Australian equities perspectives
Michael Price, Head of Fundamental Equities
Financials and resources were the sectors that underperformed on the ASX200 after the Brexit result was known. Defensive yield sectors outperformed. The relative sector performance reflected expectations of lower global growth and bond yields going forward.
We anticipate that lower global growth and bond yields will lead to resurgence in the yield trade. The Australian market has rallied for three years without earnings growth and could be considered expensive and vulnerable to a loss of global confidence.
It remains unclear whether Australia will be regarded as a safe haven or a vulnerable economy.
Global infrastructure perspectives
Tim Humphreys, Global Head of Listed Infrastructure
In the initial aftermath of the Brexit vote, global listed infrastructure slightly outperformed global equity markets, in-line with the defensive characteristics of the sector. The direct implications on infrastructure stocks of Brexit are likely to be quite small.
Listed infrastructure companies in the UK (largely regulated utilities) have very little exposure to the economy, largely protected against inflation and have access to long term funding. Outside of the UK some companies, like Eurotunnel, and European airports are exposed to the UK economy via trade and tourism flows, but we expect any impacts from these linkages to be small and short-lived.For listed infrastructure companies, the exposure to economic developments varies, but generally speaking they are very well-capitalised and benefit from stable regulation or long term contracts.
Although the direction of markets remains uncertain given the backdrop of Brexit, we expect the global listed infrastructure sector to continue to demonstrate its defensive characteristics and perform well relative to broader equity markets. In the medium term, we see the most attractive risk adjusted returns in Continental Europe, which represent our largest overweight position, partially offset by an underweight to the UK.
Global listed real estate
Matthew Hoult and James Maydew, Co-heads of Global Listed Real Estate
In-line with its typically defensive characteristics, global REITs outperformed the broader equity market in the initial market movements. However, all risk assets, including global REITs, have experienced substantial price declines as equity risk premiums have risen in response to heightened uncertainty. Currently, UK listed property is the weakest subsector despite lower leverage and sound direct property fundamentals.
Taking price reactions at face value, the clear implication is that property demand in London and the UK broadly is likely to diminish considerably, particularly as key financial and technical tenants look to relocate to the continent. This may indicate an overreaction, as London was a financial centre long before the European Economic Committee even existed, but at the margin it is certainly fair. Interestingly, with the concurrent selloff in property names in Europe, the implication goes beyond demand forecasts as for every tenant that leaves London you would expect some offsetting, increased demand in Paris, Frankfurt or elsewhere. Extending this around the world, it is increasingly clear that the selloff has less to do with demand forecasts in London and the UK, but with Brexit acting as a catalyst for a long feared market correction.
Direct real estate
Carmel Hourigan, Global Head of Property
Sharemarket volatility is likely to see reduced capital for unlisted assets in the short-term but once the volatility subsides, the attractive real estate yields in a world where fixed interest yields are going to fall further is likely to rekindle the demand for yield assets again.
Mortgage rates were already rising and banks were tightening lending prior to Brexit. As such, the property market has not collapsed it’s merely stabilising. We expect the Reserve Bank will drop interest rates so the burden on households may actually lessen. In our view, the oversupply of apartments is likely to have a bigger bearing on prices in localised areas than Brexit.
Debt usage in real estate has fallen since the global financial crisis, so the risk of fire sales and big falls in real estate prices outside of the UK and Europe seem unrealistic this time. However, there is a risk of tighter credit markets globally in the wake of Brexit which could impact availability and pricing of real estate debt, again acting as an offset to improving rent and occupancy rates. For Australia, we see more stable markets ahead with the potential of slightly more expensive debt.
We believe Australian core real estate will remain attractive on a relative basis globally and are likely to see continued interest from pension fund investors out of Europe.
While the immediate impact across regions and markets has varied, it is apparent that Brexit has increased uncertainty about the future. The medium term broader implications of the Brexit referendum lie with Europe and, particularly, relate to the sustainability of the European Union as we know it; anti-EU political movements have seen strong support in countries like Italy, France and the Netherlands, whilst the economic recovery from the Eurozone crisis in 2011-12 has been weak with relatively high unemployment rates and banking sector under pressure.
SMSF Investors should continue to gather information and assess the medium term implications, when considering their SMSF strategy and asset allocation.