Investment Strategy 21 June 2016

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ABN AMRO Private Banking

In the run-up to the British vote on staying in the EU, the Global Investment Committee left the asset allocation unchanged at its meeting on 16 June. It continues to reflect a modest overweight in equities, an underweight in bonds and a significant overweight in cash. Commodities are overweight, with neutral allocations to real estate and hedge funds.

Over the past few days, risk aversion has increased in anticipation of rising uncertainty related to the UK referendum regarding its EU membership. Volatility has increased, as polls regarding the outcome of referendum have narrowed and the results flip between Remain and Leave. The vote will take place on 23 June. If there were to be a vote to leave, uncertainty would likely continue for some time. Much would also depend on the nature of the exit, e.g. if it were to become messy or go smoothly. Given the decline in market sentiment that has been recently seen, a vote to remain could result in a post-referendum rally. Group Economics continues to believe that Britain will vote to remain in the EU, although it is a close call.

Equity fundamentals remain supportive

Outside of the Brexit issue, the fundamentals supporting the overweight equity position remain in place. Continuing low interest rates support the relative attractiveness of stocks over other asset classes. Oil prices have stabilised and some improvement in earnings growth is expected later this year and in 2017. Defensive growth companies continue to be favoured. The health care and information technology sectors are the most-preferred sectors, while utilities and financials are the least-preferred sectors.

The regional allocation is neutral regarding the US versus Europe, with a tilt toward emerging markets Asia. Within Asia, China has been moved to neutral from overweight, in light of weak earnings-growth momentum. South Korea, which is attractively valued and the only Asian market with positive earnings revisions since the beginning of 2016 was moved from neutral to overweight.

Bond yields still low and yield curves are flat

During the recent risk aversion by markets, government bond yields have declined due to a flight to quality and central bank actions. Periphery bond yield spreads have widened. Corporate spreads have been boosted by the purchase programme of the ECB, which was initiated last week. The decision was made to further reduce the position in Spanish government bonds, in light of the potential negative effect of a vote by Britain to leave the EU and Spanish elections on 26 June. The proceeds were reinvested in European corporate bonds, which in addition to the purchases by the ECB are also supported by robust fundamentals and decent valuation.

British pound weakens ahead of the EU referendum

As financial markets became more nervous about the Brexit referendum, stress in the foreign-exchange options market increased, with demand rising for downside protection. While volatility was initially largely contained to the options market for the British pound, the spot market is becoming increasingly nervous. Since the end of May, the pound sterling has fallen by more than 3.5% versus a basket of currencies.

Currencies with safe-haven attributes, such as the yen and the US dollar (in addition to gold) have performed well. As long as the Brexit polls remain close, uncertainty will likely continue to trigger weakness for the British pound sterling.

Modest growth to continue

Political risks are rising, as the UK’s Brexit vote approaches, Spanish elections are in the offing, the US presidential campaign begins in earnest and, next year, there are general elections in Germany and France. The global economy is, however, plodding along and the general outlook for the next 12-18 months is relatively positive. Group Economics expects the environment of modest growth, low inflation and supportive central banks to continue. Chinese policymakers also appear committed to supporting growth and are on track to achieve a “soft landing” of the Chinese economy. Recession fears in developed markets have also faded.

The Global Investment Committee believes it remains an environment for agility and international diversification. Agility means keeping a buffer of cash to reduce the overall risk of the portfolio and to be ready to invest to benefit from the opportunities created by market corrections.

Over the past few meetings, the GIC has taken several steps to insulate the portfolio from the risks of a decision by Britain to leave the EU. These steps include reducing risk, increasing cash, neutralising the regional equity allocation between the US and Europe and reducing the peripheral government bond allocation. A core (US, Germany and Japan) government bond active duration strategy was also put in place and the overweight in commodities has been retained as an inflation hedge. A stop-loss position on the British pound hedge for US-dollar portfolios was also initiated.

The GIC is monitoring the political situation closely and will next meet in the early morning on 24 June, after the results of the referendum are known, to assess the effect of the outcome and any risks and opportunities it might represent.

Global Investment Committee
Didier Duret, Chair