Brexit – the end of the beginning

Following the Brexit referendum, there was a clear consensus in the UK government that no progress would be made in the withdrawal negotiations until November or December 2017. On this they have proved to be correct but for entirely the wrong reasons. British ministers felt then that Germany would not be paying attention to the negotiations until the results of their September elections and subsequent coalition discussions were settled. At that point the UK would meet with Mrs Merkel, sort out the main outline of an agreed deal based upon the pressure from German industry not wishing to lose a major export market. Germany would then tell the rest of the EU how it was all going to work out, and Europe would fall into line.
Instead the EU27 have appointed a negotiating team and given them a clear mandate. They have made it clear that the national governments would not get involved in negotiating with the UK. The wishes of German business leaders have been prioritised below that of the interests of both Germany and the EU as a whole. Mrs Merkel has given no indication of wishing to get involved in the Brexit talks.
Thus, until now the UK has barely proposed anything about what they wish to see as the outcome of the talks and have been content to let the EU set out their proposals. This is because of the divisions within the Conservative Party, which means that any public position of what the UK wants will incur the wrath of one half of the Party. The UK Cabinet has not yet even discussed the outlines of a trade deal they would like to secure, such is the divisiveness that any declared position will cause.
However, a critical point in the talks has now been reached. If at their December meeting, the EU27 decide that insufficient progress has been made in the Phase 1 discussions on UK payments, the customs border in Northern Ireland and the future rights of EU Citizens currently living in the UK, then the earliest point at which talks could start to discuss a transition phase and any future trade deal in Phase 2 would be March. Given that both sides have indicated that talks will need to end by November 2018 in order to seek all the national approvals required, this does not leave enough time to agree a meaningful settlement. December is the critical point in the negotiations, but not because there should be a new German government in place.
It is however, possible to see what would make an acceptable deal for the EU27, and in truth, they may just present it to the UK on a take it or leave it basis. It consists of:
a) A transition period of about two years ending between December 31 2020, the current EU budget round, and June 30 2021, the end of the current term of the European Parliament. The UK would have left the EU in March 2019 and have no voting power but would remain in the Single Market and Customs Union and be subject to all EU regulation and the ECJ.
b) Payment by the UK of a sum larger than €40bn, and probably nearer to €50bn. The UK has offered €20bn which would cover the existing level of contributions for the two year transition period. The UK is likely to agree to a further €10bn as its share of the pension deficit of EU civil servants, but payments beyond that are difficult to justify domestically unless presented as the costs of getting a deal. The EU sees this as settling the accounts on departure, the UK sees this as the price of getting a trade deal.
c) No hard border on the island of Ireland (this is now officially a red line for each of the Irish Republic, Northern Ireland and the UK). However for the EU a hard border must exist somewhere between the island and the mainland. This is unacceptable to the DUP, on whom the Conservative Party depends for its majority in Parliament. It is currently difficult to see how this can be achieved absent a highly creative solution that has not yet been aired.
d) An agreement on the rights of EU citizens living in the UK. The UK offer is to treat them equivalently to UK citizens, however this in fact removes rights from them that they hold today that UK citizens do not. If the UK insists on not improving their offer on this, then the EU27 may well accept this reluctantly, but be less prepared to concede on other issues.
It should be noted that the value of a transition deal falls quickly if it is not agreed by early 2018 – this is because companies will be forced into taking measures to cope with a Brexit in 2019 with no transition deal.
Following an agreement along the lines set out, negotiations about the future trade deal would then begin. Again, the EU position on this can now be clearly discerned.
The EU would be happy to offer a Norway-style arrangement but this requires the UK to accept free movement of workers, continued payments to the EU and acceptance of the authority of the ECJ, all three are UK red lines and unacceptable to the government.
Alternatively, they would agree to a trade deal similar to the Free Trade Agreement just signed with Canada. A Canada-like deal would offer zero tariffs on goods trade but nothing at all on services, particularly financial services. This is very acceptable to the EU, and it meets the minimum UK target of both Conservative and Labour parties of “tariff-free access to the single market”. However, it brings no benefit to the UK services sector, the strongest part of the UK economy, and in truth paying €40bn to land such a deal would be hard for many in the UK to approve.
There is little desire, or need, for the EU to agree to anything else – in the end it is likely to be a “take it or leave it” offer to the UK. The UK is left to choose between a set of very unappealing economic options, as the price for its political desire to “take back control”.

The 5 errors of the Free Trade Brexiteers

For many of the proponents of Brexit in the referendum debate (Messrs. Gove,
Fox and Johnson in particular), free trade was a crucial part of their argument
on two grounds.

First, they argued that Britain would be able to agree a satisfactory trade deal with the EU following Brexit because the rest of the EU ran a sizeable trade surplus with Britain. Secondly, they argued that, outside the constraints of the Customs Union, Britain would be able to agree advantageous trade deals with other countries around the world (US, China, India) that the EU had not been able, or prepared, to do.

Some fourteen months on, these pre-referendum theoretical arguments have
come in to contact with real world, and five key errors can now be seen in their

1. Their argument was based on the absolute size of the EU’s trade surplus:

Whilst almost half of the UK’s exports go to other EU nations, less than 10% of their exports come to the UK. Though the UK runs a deficit in trade with the EU in absolute money terms, relative to the size of the total EU economy their surplus is not very meaningful. Thus, if political considerations were deemed to be important (which events since the referendum have shown to be the case), it would be quite conceivable that some modest economic loss would be acceptable in exchange for other, more political gains.

2. Their arguments were based on an old economic, and now irrelevant,
theory that tariffs are the only thing that matter in international trade:

Two hundred years ago, Ricardo developed an economic theory demonstrating the advantages of untaxed international trade in boosting the economic well-being of all countries. The UK, with its Empire, large navy and entrepreneurial flair benefitted enormously from conducting trade all over the world. Thus, the UK’s history and attachment to the concept of free trade and drive to reduce or eliminate tariffs imposed on the import of physical goods into a country. This has been supported by a clear consensus of conventional, neoliberal economists through the decades since.

Today, tariffs on goods passing across borders are either zero or fairly close to it. There are specific areas where this is not so, principally agricultural products and cars coming in to the EU Customs Union. For goods, free trade is pretty much the norm and there is limited scope to achieve economic benefits from signing more free trade agreements.

3. Their arguments ignore the crucial role played by regulation as the
protectionist policy of choice today:

However, the key protectionist tool used by governments today is regulation. In general, this is used in service industries and is most prevalent in financial services, where protection of the major local banks insurance companies is typically deemed a political necessity, and pharmaceuticals, where the political need to control healthcare costs often impacts on purchases of specific drugs and treatments. These two industries are very important sources of UK export revenues.

Within the EU, the single market operates on the principle that if a product or service has regulatory approval in one EU nation, then it can be sold anywhere else in the EU, subject to EU-level control on what constitutes acceptable regulation. By leaving the EU, the UK will lose these advantages and will have no say on future regulatory change, but UK businesses will have to adapt to any such change.

The investment management industry is an example of an industry that looks like being particularly disadvantaged by Brexit. A substantial part of the industry’s revenues arise from managing the assets of other EU customers under MIFID regulation for investments in funds or under delegation regulation for segregated accounts. Last month, ESMA (the European Markets and Supervision Authority) published an opinion that, post-Brexit, would force more EU investment management activity to be conducted within the EU.

4. Other countries will expect us to make (politically unpalatable)
concessions in order to agree on new trade deals:

Though the US under Trump has indicated its desire to strike a free trade agreement with the UK, they have particular areas such as the food and
healthcare industries, where they would seek a change in UK regulation, before agreeing to such a deal. These are politically difficult for the UK

Both Australia and India have indicated they would be very open to post-Brexit UK trade agreements but their price would be greater access to the UK for their own people, which would make even more difficult the UK’s ability to control and reduce immigration.

5. They over-estimated the attractiveness of the UK as a free trade partner:

They argued that as the 6th largest economy in the world, Britain was exceptionally attractive as a partner in a trade agreement. However, in practice the larger trading partners are (i) China with 1.3bn emerging consumers, (ii) the EU with 500m mostly wealthy consumers and the US with 300m wealthy consumers are many times more attractive as trading partners compared with the 60m wealthy consumers the UK has. In this global perspective the UK has less than 1% of the world’s population. A trade deal with the UK is a “nice-to-have” rather than a “must-have”.

The likely outcome for the UK is now a life outside the EU, accepting their
regulation of any product or service that we wish to sell to them, whilst losing
any say in that regulation or the key political developments in our most
important trading partner. In financial services in particular it is likely that the
UK will dilute its dominant market position within Europe, as regulations
benefit EU members. The UK will be forced to make greater concessions with
other countries in trade matters than the EU would have done in order to
secure trade agreements with these countries.
The voters believed the marketing hype of the free trade Brexiteers, sadly the reality of their delivered product will not match that hype.

E for Election and E for Effort

The UK general election campaign, announced on April 18th, has been rather uninspiring so far. Whether is it a symptom of “democracy-fatigue” following two tight referenda and a hotly-contested, general election in the last 33 months, or an associated lack of funds amongst the political parties, or just the boredom of an election where the result seems obvious, no one seems to be putting in very much effort this time around in order to win it!

Theresa May, whose decision it was to call the election, appears to have decided that all she needs to do to win her expected larger majority, is to repeat “strong and stable government” at every opportunity and be photographed at various stage-managed events where all the questions and questioners are pre-selected. She has refused to enter into any direct debate with other party leaders. She has sought to frame the election as a choice of leader to take Britain through the Brexit negotiations, between herself and Jeremy Corbyn. Given her strong personal ratings and his weak personal ratings, she appears quite happy for media attention to focus on the him and the Labour party.

She has led the production of a vague and uncosted manifesto, particularly around Brexit, she has surprised many by some surprisingly detailed policies that work to the financial disadvantage of a core group of her supporters, the over-65s. All-in-all, she is giving the impression of expecting to win very easily and thus does not need to try too hard to gain votes.

For Jeremy Corbyn, this is the moment he has dreamed of – the chance to put in front of the UK electorate a Socialist manifesto and vision for the UK. However, it appears that his goal is not to win the election, but merely to do well enough that the left wing of the Labour party can say that there is a real demand for their ideas amongst a substantial section of the UK electorate. His campaign strategy has therefore concentrated on appearances in areas traditionally considered solidly Labour. His focus is on getting out that core Labour vote, and very little time of effort is being devoted to taking that manifesto to the rest of the country.

The UK Independence Party, which for many has achieved its original purpose of taking Britain out of the EU, is suffering from internal divisions and a lack of leadership and of money. – they are fielding many fewer candidates in the election, which they are justifying by saying they do not wish to put up candidates against previous strong proponents of Brexit.

Somewhat similarly, the Green Party has stood down candidates in a number of constituencies where they are seeking to promote a progressive alliance, and believe that a Liberal Democrat or Labour candidate would have a serious chance of defeating the Conservative candidate. Sadly for them, apart from in Brighton, the other parties have not acted in a reciprocal fashion.

Only the Liberal Democrats are campaigning at full volume. They have taken Teresa May at her word that this is an election about the Brexit negotiations and are the only party campaigning to remain within the EU’s single market, a very soft form of Brexit. They thought this would open up the possibility of gaining votes from the 48% who voted to stay in the EU, but current polling suggests that half of those now feel that the decision has been made and should be respected. The Liberal Democrats position is not gaining much traction with the electorate.

Maybe the excitement in British politics over the last three years is now over. A dull campaign looks likely to lead to a large Conservative majority as Britain enters the long and tortuous Brexit negotiations. No doubt a normal service will be resumed after it becomes clearer just what Britain will look like post-Brexit.

The die is cast

Now that Royal Assent has been gained, the European Union (notification of Withdrawal) Act 2016-17 is in force and the only impediment to Britain leaving the EU is for the Prime Minister to write to the EU to trigger Article 50 of the Maastricht Treaty. This is expected in the next two weeks.

The die has been cast and this British action will lead to many repercussions, not all of which are visible today. It is however true that whilst leaving the EU is a very clear demonstration of British sovereignty, it is those repercussions that will determine just how effective and valuable that sovereignty is in today’s world.

Firstly, with regard to the EU, the deal we gain through the next 24 months of negotiations will primarily be a function of what sort of relationship the EU wishes to have with Britain. It may well make economic sense for both sides to have an essentially free trade regime in goods and services, very similar to that which exists currently. However the EU also has political objectives, prime amongst which is that any deal must look and be worse than remaining within the EU and its single market, in order to deter other countries from following the UK out of the exit door. Anti-EU views are gaining ground in France, Italy and Holland, all founding members of the EEC. Some degree of economic loss will be acceptable to the EU in order to achieve these political objectives, and though this may be higher in absolute terms than the loss to Britain, that economic loss would be much smaller as a share of their total economy than for Britain.

Britain’s economic fortunes are thus dependent on the political calculations of the rest of the EU.

Secondly, with regard to the USA, a “special relationship” may or may not exist, but if it does it has always been on US terms. Pre-Trump, the UK was an invaluable bridge between an inherently individualistic US political philosophy and an inherently social European one. – Britain was able to explain and translate each side’s thinking to the other. By leaving the EU this role is hugely diminished, though may still apply to defence matters.

With Trump as President, the picture is more complex. Trump sees Brexit as part of the same changing political tide that saw him elected and Britain’s need for a series of bilateral trade agreements fits very neatly into his philosophy that the US should only negotiate bilaterally in order to maximise its own influence. He clearly enjoys visiting his properties in Scotland and he may wish to be seen rapidly concluding a trade deal with Britain in order to contrast trading relationships with other developed world economies with those of less developed economies such as Mexico and China which he believes have been detrimental to US jobs.

He is though very unpredictable, and would likely seek some painful concessions from Britain, in order to demonstrate that he had “won” the negotiation. Britain would thus be dependent on his capriciousness, both in any trade deal and more widely in global affairs.

Thirdly, China sees itself as a key world power that is happy to make agreements with other countries, but is not very interested in negotiating them. It prefers to set out its terms and wait for others to agree to them. British sovereignty would extend to deciding whether or not to agree to what the Chinese want.

These 3 giant entities (EU, US, China) account for 57% of the global economy and an even greater percentage of UK goods exports – the fate of the British export sector and thus the wider economy is very much in their hands. Britain can only “take” what they wish to “give”. In relation to the size of these economies, Britain, though the 5th / 6th largest economy in the world, has little negotiating power.

Of the other countries who have expressed an interest in early free trade deals with a Britain outside the UK, both Australia and India have indicated that a key objective in any such negotiations would be greater freedom for their citizens to come and work in the UK. This is directly counter to the British government’s policy to substantially reduce immigration. In addition all the nations seeking trade deals are a very long way from Britain and international trading relationships display very strong correlations to geographic proximity.

British sovereignty has been dramatically exercised – the die has been cast – Britain is about to set out on a new independent path for its economic development – its fortunes, however, certainly in the next few years, now depend very heavily on the actions of others. Re-asserting sovereignty may feel liberating now but be economically painful in the future.


Jeux avec frontieres

Before the UK joined the EEC in 1973, most Britons knowledge of Europe was from the BBC game show Jeux sans Frontieres (Games without Borders), which showed that Europeans were as prepared as Brits to dress up in silly costumes and attempt bizarre tasks against teams from other countries. It may even have played a part in Britain’s referendum to support EEC membership.

It is now 12 months since David Cameron permitted his government ministers to break from Cabinet responsibility ahead of the second EU referendum. The campaign and decision to leave, followed a few months later by the election of President Trump has transformed the political debate around the world. Since World War 2, the political debate was between those who thought government should seek to do less within society and those who thought government should seek to do more within society. The events of 2016 however show that the debate is now between those who would like national borders to be more difficult to cross (whether by people or goods) and those who want borders to be easier to cross.

Regarding people crossing borders, Mrs May’s immediate conclusion from the referendum was that the British people voted for regaining control of immigration, and the right to live in Britain, and that this was more important any economic benefits from EU membership. Her policy and approach to Brexit since then has clearly been dictated by that conclusion. It is however, notable, that the parts of the country most concerned by immigration are correlated to those parts of the country with the smallest immigrant populations.

For President Trump, it is the twin threats of illegal immigrants from Mexico and radical Islam from some Muslim nations that underpins his desire to establish more effective control of America’s borders. His geographical distribution of support in the election also correlated with low levels of immigrant population.

For Trump, though not for Mrs May, borders are also important for controlling the movement of goods. He argues that the free trade agreements that the US has made in recent years has meant that cheap goods have poured into the US , displacing US-made goods and thus US jobs, particularly in the areas where he drew the greatest support. He seeks to maximise American negotiating leverage by withdrawing from multilateral trade agreements such as the TPP and NAFTA and replacing them with bilateral agreements where the US will (nearly) always be the more powerful party and be more likely to reach agreements that are closer to American interests.

For the UK, voluntarily withdrawing from a trade bloc even larger than the US and seeking new trade agreements with the rest of the world, the general acceptance of free trade is paramount and much rhetoric about the UK being the beacon of free trade in the world (and goods and services crossing borders easily) can be heard from UK Conservative politicians. One early issue that UK politicians have discovered is that many of the countries (eg India and Australia) that would be keen to enter into free trade agreements with the UK, are also seeking greater freedom for their people to enter and stay in the UK.

Unusually for economists, almost all of them agree that free international trade is a good thing for the global economy (though this is not the same thing as being good for everyone in that global economy), and that the last time, the world economy saw a significant increase in protectionism, in the 1930s – this was associated with dramatic declines in trade levels and a global economic depression – ending in World War.

This desire for reinstatement of borders also flies in the face of the reality of technological progress. For people travel across the world is cheaper, more straightforward to plan and a more realistic aspiration that ever before in history. Making that more difficult implies a key loss in economic terms

For goods, bar codes, the standardisation of shipping container and the prevalence and complexity of international supply chains supported by logistical improvements has created huge efficiencies with both higher volumes of trade and lower prices for all. Re-establishing border controls (not only between the US and Mexico but also between the UK and the EU) will raise prices and reduce the global standard of living, even if tariffs remain at negligible levels.

For services, the digitisation of the world means that borders are increasingly irrelevant. More and more retailing is conducted in the ether, a large part of the world satisfies its desire to watch soccer by watching the English Premier League online, even investment bankers outsource research model-building to staff in India.

The current wave of national populism is selling the idea of greater security through control of borders and plays on traditional human tribal urges to discriminate against outsiders. It appears to be going against where technology is taking the human race and the risk must be that to deliver border control will require increasing levels of force, militarisation and regulation that will act to reduce standards of living. It also flies in the face of another great human urge – to welcome and be hospitable to visitors.



An era is ending

A year which sees Britain vote to leave the EU and the US vote Donald Trump to be their President is clearly one which could be said to be the beginning of a new era. Perhaps of equal significance is the fact that an old era is ending, which may well have played a part in enabling this new era to begin.

Jim Callaghan’s remark to the BBC in 1976 that “We used to think that you could spend our way out of a recession … I tell you in all candour that that option no longer exists” marked the end of the post-war consensus on Keynesian demand management of the economy and the primacy of fiscal policy over monetary policy in economic policy-making. Since then monetary policy has been dominant, and changes in interest rates have taken the lead in adjusting the course of the economy. Central banks have become independent given the crucial (technocratic) role they are believed to play in the modern economy.

However, recent experience shows that at very low interest rates, further monetary easing has little and arguably, counterproductive, impact on the economy and the central bankers at the Fed, Bank of England, ECB and Bank of Japan have all made it plain that they cannot deliver the faster growth that governments are depending of them. At zero or even negative interest rates and substantial Quantitative Easing, we have reached the limits of effective monetary policy. Even if the next move is “helicopter money”, this is as much a fiscal policy as a monetary policy. The era of monetary policy primacy is ending.

The era of trade policy liberalisation that started in the mid-1980s is also ending (as discussed here) – no major new multilateral  trade deals have been struck for about a decade and the recent TTP and TPP deals look like they will not survive contact with Donald Trump. In addition, NAFTA looks unlikely to survive in its current form and whatever the outcome of the Brexit negotiations, trade between the UK and the EU will be less free than it is today. 2015 marked the first year in decades that the growth in world trade was slower than the growth of world GDP – trade has acted as an accelerator for the world economy, now it is acting as a brake. The message from the successes of both Brexit and Trump is that national borders will be subject to greater controls and it will be less easy for people and goods and services to cross them. The era of greater openness is ending.

The effects of these two major eras has been most clearly seen within financial markets in the 35-year bull market in government bond markets of Western nations. The eye-wateringly high interest rates required by monetarism in the early 1980s to combat inflation have given way to the “rigged” bond markets in which central banks have become some of the largest owners of their own bond markets. It is not yet clear that this bull market is over, but a world of fiscal policy primacy over monetary policy is likely to have higher interest rates and bond yields.

This bull market has supported and inflated the markets in all other financial assets as the risk-free rate of return has declined, creating large gains both for those invested in financial assets and for those firms that aid and service them. This “financialisation” of the economy, in which the financial sector has been growing faster than the rest of the economy over this period has been a major trend.

The big winners of this trend have been the asset managers – attractive market returns have attracted strong inflows of assets and substantial economies of scale have nearly all accrued to the fund managers rather than their investors. The recent report from the FCA on the asset management industry highlighted that it was one of the industry sectors with the highest profit margins. Asset managers now top the tables of highest-paying industries, having recently overtaken investment bankers, for whom profitability has been of increasing concern since 2008. The attention of the regulators has noticeably shifted in recent years from banks to investment managers. The asset management era, which began in the early 1980s, may also be peaking.

All these trends began between 30-40 years ago, and all have showed distinct signs of ageing in recent years. The dramatic events of 2016 may represent the “coup-de-grace” for them and the conclusion must be that the future will look increasingly different from the past.

Fiscal policy will become more important than monetary policy, international trade will come under increasing pressures, bond yields will not always fall, the financial sector will fall back as a proportion of the economy and the profit margins of the asset management industry will decline.

Brexit with Trump

Just six months ago, the probability of victory for each of Brexit and Trump were 30% – and the odds on the double were thus 10-1 against. The world going into 2017 looks a very different and more uncertain place than it did a year ago.

However, Trump’s victory provides the UK with an opportunity to gain a substantially better agreement with the EU than it would have done with a Clinton victory, even though Mrs. Clinton may well have leaned on the EU countries to give the UK a sensible deal.

Trump’s victory has many European governments feeling considerably less secure. With his outspoken admiration of Vladimir Putin and his tendency to see foreign relations as a zero-sum game rather than mutual gains through international agreements, Trump’s view of NATO and European security is very different from his predecessors. For those in Eastern Europe, Putin is today a bigger threat to their borders and US military support less likely to be forthcoming.

One of the few cards that the UK holds in the Brexit negotiations is it deep and unwavering commitment to the military defence of its European allies, and despite the harsh words used against the rest of the EU from those seeking to leave the EU, their military support for the EU has not changed and they have consistently voiced this before, during and since the referendum. That support has now become much more meaningful and valuable, especially to those countries in the former Eastern Europe. 

The desire to punish the UK for its audacity to leave the EU is now (post Trump) more likely to be to seek a strong agreement with a staunch ally who is also a nuclear power. On the Maslovian hierarchy of needs, the basic security of your country is a far more powerful force than the continued existence of a financial passporting system or some controls on the uninhibited movement of people between countries.

In addition, once again, through their votes, the UK and the US have shown the similarity of their thought processes (a clear parallel being  the ascensions of Thatcher and then Reagan), which often baffle European minds.  Maintaining a close and friendly relationship with the UK is likely to be helpful to Europeans in understanding and interpreting the actions of the US. Trump has spent time in the UK (though mostly in Scotland), has openly identified his success with Brexit and did

promise to put the UK at the front of the queue for a trade agreement post-Brexit, following Obama’s threat that it would be at the back of the queue. Though of course this would be strictly on Trump’s terms, and have almost no cost to US jobs – it would enable him to show that there are some trade deals he will do if they are right for the US. The EU-US trade deal, already stymied by European doubts before Trump’s  success is now dead in the water.

Trump’s victory will change the world in many ways, but one of the more surprising ones is likely to be that the UK obtains a better exit agreement from the EU than would have occurred without Trump.

The giants of Multi-Asset Absolute Return fund sector

This was originally published in Investment Week

In recent years, the fund sub-sector seeing the greatest inflows has been the Multi-Asset Absolute Return sector, home to several of the largest individual UK funds. The attraction to investors of these funds has been the promise of returns well above cash for limited amounts of volatility, and sophisticated investment processes aiming to exploit opportunities across all asset classes. The giants of the sector are shown in the table.

AuM £m Fund 1 yr ret % 3 yr ret % 5 yr

ret %

Launch date
26,560 SLI GARS -2.4 7.7 23.2 29/01/08
9,824 Newton Real Return 11.2 15.8 28.4 01/04/04
7,197 IP Glob Target Return 3.0 16.2 na 09/09/13
2,562 AIMS Target Return -0.4 na na 01/07/14
1,571 AIMS Target Income 2.6 na na 30/11/14

Source: IW 10/10/16, fund factsheets

Funds such as Fulcrum Diversified Absolute Return and Goldman Sachs Global Absolute Return have similar objectives and approaches but have not yet seen investor flows to the same extent.

All of Newton, SLI and IP have, to date, broadly achieved their return and risk objectives over the recent 3 or 5 year horizons, but it is noticeable that none of these funds have generated much performance from the large decline in sterling post-Brexit (Newton have held a relatively high sterling weight in recent months.  This is in stark contrast to most of the more traditional fund sectors where beta returns predominate, which have been significant beneficiaries of sterling’s fall.

Hindsight shows that, once again, where funds flow from investors is heavily focussed in one sector, that sector tends to lag in performance behind less-favoured sectors.

Newton Real Return is the Grandfather of the sector, launched over 12 years ago, aiming at long term returns of cash +4% before fees over rolling 5 year periods and positive returns over rolling 3 year periods. They aim to achieve this by investing predominately in equity and bond markets, and control net market exposures through active hedging of equity and currency market risk. It can be best seen as a balanced fund that actively hedges its total equity exposure. Iain Stewart has been in charge since the fund’s launch and has delivered a positive return in every calendar year to date. This was particularly noteworthy in 2008 when the portfolio was well prepared for collapse in equity markets, but performance was disappointing in the 2012 to 2015 period when he held a relatively cautious view on equity markets. However, the last 12 months have returned 11.2% as the exposures to long duration government bonds and to gold have paid off handsomely, in addition to strong equity sector selection performance. This recent good performance has more than recovered the prior lagging performance, whilst maintaining low volatility.

SLI Global Absolute Return Strategies is the Big Daddy of the sector, the largest fund in the entire UK funds market, launched in early 2008, aiming at returns of cash +5% before fees over rolling 3 year periods. It uses a combination of traditional assets such as equities and bonds and modern strategies that make use of advanced derivative techniques, which give access to other asset classes such as interest rates, volatility and inflation. These techniques mean that the gross positioning of the fund has often exceeded 400%, though the rigorous risk control measures have meant limited portfolio volatility over the life of the fund. It is most easily understood as a hedge fund, though without the performance fees. The portfolio consists of around 40 different “ideas” which are each expected to deliver positive returns on a 3-year view, which are then blended together. For an advisor or end-investor it does mean that it is difficult to understand how the fund is actually invested in contrast to the far more straightforward portfolio positioning used and reported by Newton.

An otherwise very steady performance record has been damaged by the fund’s struggles over the last year, with a loss of 2.4% over that period. The team have struggled with their key long term market view of a stronger US economy, and this view was reflected in many of their positions, in particular their short duration position in US bonds, the significant long position in the dollar and a US Banks v Consumer Staples equity position. Some fund research houses also have cited the sheer volume of assets now managed by the GARS team (over £150bn) as a possible factor behind its declining performance in recent times.

Invesco Perpetual Global Targeted Returns is more like the oldest son in the sector. It was launched when three of the GARS investment team left SLI to move to Invesco Perpetual in 2013 and it adopts a similar investment process, though tends to operate with fewer individual ideas at any one time. Like GARS its gross positioning is substantial and makes considerable use of complex derivative techniques and aims to generate a positive return of cash +5% before fees over rolling 3 year periods with less than the volatility of global equities.  One difference in approach is that many of the talented equity managers at Invesco, such as Mark Burnett, manage equity “sleeves” for the GTR team thereby adding an extra element of return from individual stock selection that has absent at SLI.

AIMS Target Return and Target Income are the younger son and daughter of this family. Target Return was launched in July 2014 and Target Income in November 2014. Euan Munroe who built the original GARS fund is now CEO of Aviva Investors and the whole of their business is now centred around providing ideas for the multi-strategy fund range. The Target Return fund, like the others in the sector seeks positive gross annual returns of cash + 5% over rolling 3 year periods. In its objectives and approach the fund is similar to the SLI and IP offerings.

The Target Income fund, unique within the sector, seeks a pre-tax income return of cash +4% pa paid monthly, whilst maintaining the capital value after fees, regardless of market performance. In order to generate the high level of income targeted, a large part of the portfolio has to be invested in high-yielding equities and in bond markets, typically taking on some credit risk. Market hedging, multi-asset ideas and techniques are then added to the portfolio in order to seek to produce an absolute return profile.

Neither fund has yet built a 3-year track record – both performed well from launch until April 2015, but have struggled to make further gains since then.

In the down phase of the trade deals cycle

The UK’s referendum decision to leave the EU, leaves it seeking new trade deals not only with the rest of the EU but also with the 50 or so nations with whom the EU has trade deals in place. The new minister for International Trade (Liam Fox) has also indicated that he would be keen to see trade deals with the US, Canada, Australia, New Zealand, India and China. Without trade deals, countries may impose tariffs on imports of goods and stiff regulations on imports of services.

Not only does the UK have very few experienced trade negotiators, since this has long since outsourced to the EU but the UK’s demand to make trade deals comes at a most inopportune time in the trade deals cycle. Recent events indicate the momentum and desire for agreeing trade deals have reversed.

The trade deals cycle began to turned upwards in 1986 when talks for the Uruguay Round within GATT began – with the free market philosophies of Thatcher and Reagan leading the way for countries to reduce the barriers to international trade that were in place. The talks concluded successfully in 1994 with an agreement that reduced global tariffs on goods substantially, so boosting the volume of trade. Other key free trade agreements have been NAFTA which came into force in 1994, the development of the EU Single Market in the 80s and 90s, where Mrs Thatcher did much to drive progress.

As part of that agreement the World Trade Organisation was set up in 1995 to take over GATT’s responsibilities for matters relating to international trade. In 2001 the WTO initiated the Doha Round, at the same time as China was admitted to membership of the WTO. The accession of China to the WTO saw a further dramatic rise in global trade volumes until 2008.

In hindsight this was peak of the trade deal cycle and agreement between nations to reduce trade barriers. No significant progress has been made since then.

The aim of the Doha Round was to further reduce global trade barriers especially within agriculture and services. It had an original deadline for an agreement by 2005, but was plagued by difficulties – negotiations collapsed in Geneva in 2008 and the Global Financial Crisis has meant that since then national governments have been unwilling to make concessions that might harm their citizens.

In recent years, following the collapse of the Doha Round there have been three attempts at major non-global trade agreements. These are between (i) the US and the EU via the TTIP (Transatlantic Trade and Investment Partnership) talks, launched in 2013, (ii) the US and other American and Pacific nations via the TPP (Transpacific Partnership) and (iii) Canada and the EU via the CETA (Comprehensive Economic and Trade Agreement) talks, negotiated between 2009 and 2014.

Of these TTIP talks have got stuck – the original intention to conclude by 2014 has been extended to 2019 but across Europe there is increasing unhappiness at the secrecy of the proposals and the progress of negotiations. The TTP talks produced an agreement but requires ratification from the US – during the campaign Donald Trump has stated his opposition to this and other trade agreements and would not ratify it, and Hillary Clinton, having been a supporter of it when in government has now said that she would not ratify it. The CETA has recently run aground as EU ratification of the Treaty requires each of the 28 member states to ratify it individually and Belgium cannot do so without the agreement of the Walloon parliament, which is currently firmly opposed to doing so, seeing as a further dangerous step towards globalisation.

Trade deals have lost their political support and the momentum of the trade deal cycle is now firmly down. Though the UK and the rest of the EU ought to be able to agree on a post-Brexit trade deal given the economic benefits to both sides, for the UK to conclude many other significant trade deals is likely to be a very long and arduous process.

The UK’s post-Brexit need for free trade deals will prove to be cyclically poorly-timed and a negotiating weakness at a time when countries are growing increasingly suspicious of the benefits of such deals.


A hard Brexit please

This week the government made clear its decision regarding the sort of Brexit it will be seeking. The red lines of control of immigration and withdrawal from the European Court of Justice’s jurisdiction represent the “taking back control” that the Leave campaign promised.

The other 27 countries in the EU have made abundantly clear that the price of Britain denying freedom of movement is that it cannot continue to be inside the single market –  the working definition of a hard Brexit. Thus some sort of agreement on how trade will be conducted between Britain and the EU will be required.

There appear to be two key areas to be negotiated before Britain actually leaves – (i) a transitional trade agreement pending a more permanent agreement which might take many years to conclude and (ii) an agreement on the financial services sector and the current passporting system.

It is interesting to note that the red lines regarding “taking back control” do not include the subject of the UK’s net contributions to the EU budget and it seems that Britain may be prepared to pay (financially) for a transitional trade agreement and agreement over continued financial services passporting. Whether this would be acceptable to the EU countries is not clear – the current payment from the UK of £18bn per year (which would presumably be the maximum that Britain would be prepared to pay), does not go very far when spread around 27 countries.

Whilst now is the time of maximum pessimism about Brexit negotiations -before formal talks have even begun and with each side setting out their red lines – Britain has lost goodwill in Europe over the last week following policy ideas announced at the Conservative Party ‘s regarding foreign-born workers.

Both Merkel and Hollande have made clear that it is important for them that Britain should be not be seen as having won anything by deciding to leave the EU, and though it is quite possible neither will be around to have much influence over the negotiations, their fellow-countrymen are unlikely to have very different ideas.

With important votes and elections in Italy, Spain, France, Netherlands and Germany over the next 12 months, little progress should be expected in the Brexit talks in that time period. This will prove negative to the world’s view of Britain – the pound has continued its post-referendum decline this week, and gilt yields have risen in anticipation of the higher inflation this is likely to create in the British economy.

International investors will at best defer further investment into the country and at worst begin making adjustments to their factory and office locations to reflect a Britain outside the single market. Any good news regarding the benefits of new trade agreements with other non-EU countries will have to await the outcome of talks to agree our relationship with the EU.

By announcing when it expects Article 50 to be triggered and its red lines, Britain has now entered a period of massive vulnerability for its economy. Maintaining the goodwill of the other EU countries should now be a key objective of foreign policy.