Pacific Funds, June 2016
The Brexit decision will have profound longer-term consequences for the U.K., eurozone, and beyond. Pacific Funds portfolio managers discuss their reactions to the decision from an equity, fixed income, and asset allocation perspective, as well as where opportunities may exist in this new global landscape.
(Rothschild & Co Asset Management US Inc., subadvisor to Pacific FundsSM U.S. Equity Funds)
Friday morning, investors in the U.S. awoke to learn that Brexit — the name for the referendum on the United Kingdom (U.K.) exit from the European Union (EU) — had passed. This news came as a surprise to markets, which subsequently traded lower not just in the U.K., but in continental Europe, the United States, and much of the globe.
While Rothschild & Co Asset Management US Inc. manages U.S. equity strategies (rather than European ones), risk controls play a key role in our investment process and portfolio construction. Below are some observations relevant to our strategies leading up to and immediately following Brexit:
- Prior to the referendum, we reviewed our U.K./EU exposures for each company we hold.
- Following the outcome of the referendum, in general, market liquidity has been as good as normal, or maybe even slightly better.
- Our trading activity has been normal. We made a few marginal additions/reductions.
- With regard to specific securities, we are not aware of any liquidity issues, though selling pressure is high on obvious EU/U.K.-exposed stocks in our area of focus (domestic stocks).
- The short-term impact to the U.S. is likely to be felt in the form of a strengthening dollar, which could hurt exports at the margin.
- We expect that many central banks around the world will contemplate easing actions in the wake of the referendum.
Geopolitical events can impact markets. In periods of uncertainty, we have found that remaining disciplined and relying on a repeatable, bottom-up process – as opposed to making big macro investments – have served our clients well. Echoing the British mantra, we will “keep calm and carry on,” searching for stocks with relatively attractive valuations and the potential to exceed expectations.
(Pacific Asset Management, manager of Pacific FundsSM Fixed-Income Funds)
As a result of the historic vote in favor of the U.K. leaving the EU, capital markets reacted with weakness across almost all risk assets. Gold, the U.S. dollar, and U.S. Treasurys were priced higher. Below is our summary on the situation and how this might affect our markets in the future:
- The long-term uncertainty regarding something of this magnitude is a concern. Currency, trade, labor mobility, banking, etc. are just some aspects that will have high degrees of uncertainty. It will most likely lead to higher risk premiums and less risk-taking from a fundamental and capital market standpoint. The economy of the U.K. is widely expected to slow down and possibly enter recession by later this year.
- Another main concern is the slippery slope of other countries requesting to leave the EU. It is speculated that due to this concern, it would be in the best interests of other countries to punish the U.K. for their decision in an effort to limit political contagion.
- Central bankers from the European Central Bank, Bank of Japan, Bank of England, and People’s Bank of China have stated an intention to intervene if needed.
- Federal Funds Futures, which are often used to express the market’s view on the likelihood of changes in U.S. monetary policy, indicate that the Federal Reserve’s next move is more likely to ease than to hike.
- From our investment perspective, in the period prior to this, we have either been reducing risk or holding a cautious position. We would have considered entering some positions if we felt the credit markets had overdone some selling. However, that simply did not manifest; thus, we only made minor adjustments.
- We view this event as both a short-term and long-term negative for risk markets. However, short-term volatility and long-term uncertainty may present investment opportunities for our portfolios as a result.
Our bottom-up, selective, team-based approach to credit has helped us weather some of the most difficult and volatile periods in capital market history. We believe in this approach, will maintain this approach, and expect it to serve our investors well over the long term.
(Pacific Life Fund Advisors LLC, investment advisor to Pacific FundsSM Portfolio Optimization Funds)
The result of the vote in the U.K. may have profound longer-term consequences and change the political outcomes of several upcoming elections in the EU. We are maintaining a cool head and examining the region to ensure our positioning will align with these evolving fundamentals. Below are some more specific thoughts:
- The "Leave" result leads to the U.K. opening a two-year process for negotiations with the EU and uncertainty will remain high until there is more clarity on the actual structure of the U.K.’s exit.
- International equities may remain volatile over the short term.
- This will likely lead to more broad easing and lower interest rates as central banks try to limit the impact to equity markets, and ultimately consumption and investment.
In anticipation of potentially higher volatility, we adjusted the portfolios ahead of the U.K.’s Referendum, or Brexit vote, in June. Broadly, we reduced exposure to riskier asset classes to help mitigate the effects of this type of event.
- The changes included a reduction of overall equity exposure in funds.
- In addition, assets were shifted toward fixed income with an increase to core bonds, reflecting a broad-based de-risking within our fixed-income positions.
While our reduction in risk definitely improved our positioning going into the vote on Brexit, we still retain higher international exposure than peers, which may impact performance. Our currency positioning might also provide additional stability because our currency portfolio was short the British pound going into the vote on June 24.
This commentary reflects the views of the portfolio managers through 06/28/2016. Rothschild & Co Asset Management US Inc.’s, Pacific Asset Management, and PLFA’s views are subject to change as market and other conditions warrant. No forecasts are guaranteed. This commentary is provided for informational purposes only and is not an endorsement of any security, mutual fund, sector or index. Information contained herein has been obtained from sources believed to be reliable, but not guaranteed.
Rothschild & Co Asset Management US Inc. is unaffiliated with Pacific Life Insurance Company.
All investing involves risk, including the possible loss of the principal amount invested. The value of a fund’s holdings will fluctuate so that shares, when redeemed, may be worth more or less than their original cost. Corporate securities involve risk of default on interest and principal payments or price changes due to changes in credit quality of the borrower, among other risks. Investments in foreign markets are subject to regulatory, political, economic, market, and other conditions of those markets, which can make these investments more volatile and less liquid than U.S. investments. Asset allocation and diversification do not guarantee future results, ensure a profit, or protect against loss.
You should consider a fund's investment goal, risks, charges, and expenses carefully before investing. The prospectus and/or the applicable summary prospectus contain this and other information about the fund and are available from your financial advisor. The prospectus and/or summary prospectus should be read carefully before investing.
Pacific Life Fund Advisors LLC (PLFA), a wholly owned subsidiary of Pacific Life Insurance Company, is the investment adviser to Pacific Funds Portfolio Optimization and is responsible for determining the asset allocation mix for each portfolio. PLFA also does business under the name Pacific Asset Management and manages certain portfolios under that name.
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