As we all know, the UK’s vote to leave the EU in June took the markets by surprise, leading to a depreciation in sterling and an initial kneejerk slide in UK equities. It also represented another nail in the coffin for the political polling industry after its failure to predict a Conservative victory in the 2015 general election.
Equally surprising perhaps has been the resilience of much of the economic data, which so far has defied the gloomiest predictions of the UK being plunged rapidly into recession. Exports are benefiting from the weakness in sterling, retail sales have been strong and consumer confidence has proved robust.
Indeed the IMF, which intervened very publicly in the campaign with stark warnings about the impact of the vote, has since admitted it was overly pessimistic and forecast that the UK will be the fastest growing G7 economy in 2016, while continuing to signal a negative impact beyond.
Neither did the vote for Brexit trigger a systemic meltdown in global markets as some had feared. Indeed, the UK equity market has bounced back strongly on the tailwinds of the favourable impact of overseas earnings being translated into a weaker pound, as well as ultra-accommodative monetary policy.
Despite the negative impact of the vote for the UK’s outlook, borrowing costs have sunk lower, rather than risen, as the Bank of England slashed interest rates to a record low and launched another round of QE. Does this mean from an investment perspective Brexit has been a storm in teacup? The answer to that is no, as the UK is only at the start of a divorce process, the outcome of which is far from clear and there will be many moving parts.
Take for example, sterling weakness, which has dominated recent headlines. This is a double-edged sword that on the one hand improves the export competitiveness of some firms, but on the other hand will also have an inflationary impact that will hike input costs.
While the post-referendum economic picture has been better than expected so far, these are undoubtedly early days and bumps must be expected in the road ahead as negotiations on the terms of the UK’s exit begin next year.
For UK investors and advisers, one of the key stories in the immediate aftermath of the vote was the freezing up of many of the industry’s open-ended commercial property funds. But this was a story that began to take shape well ahead of the referendum vote, as funds had already seen a trend of outflows since the start of the year as forecast future returns had mellowed and risk-aware investors had been reducing exposure to illiquid assets.
This steady trend of outflows during the months in which much of the investment industry and public expected a “Remain” result will have likely seen cash buffers reduced at some funds.
When confronted by the shock outcome of the vote, and in the absence of actual transaction data, groups started to apply adjustments to portfolio valuations to err on the side of caution.
Individually these measures were understandable and aimed at being prudent in the face of a potential shock, but collectively they may have had the unintended impact of sparking panic and accelerating redemption requests.
When the first funds began suspending dealing altogether and national newspapers hungry for stories about the fall-out from “Brexit” began drawing parallels with such closures and similar actions taken by property and money market funds at the height of the global financial crisis when Lehman Brothers collapsed, it became almost inevitable that many other funds would follow to stop a stampede.
While such fund groups incurred the wrath of investors who were rushing for the exit on their funds, it is clear that temporarily suspending dealing was the right thing to do. It does not make sense for either departing or continuing investors in a property fund for a portfolio to be rapidly liquidated in a disorderly manner at a point of maximum uncertainty.
Back in the summer there was a political vacuum with the resignation of prime minister David Cameron, fears about the immediate impact on the economy and very little line of sight on where valuations might head. The lurid parallels with the period following Lehman Brothers going bust were certainly overdone, as while the UK’s exit from the EU will create headwinds for the economy and parts of the property market, the banking system is not teetering on collapse as it was eight years ago and the supply of credit, far from drying up, is abundant.
Brexit is undoubtedly creating headwinds for parts of the property market. Most notably that is in the London office market, given the serious concerns about a potential loss of regulatory passporting rights for financial services firms, which may result in jobs and functions being relocated to other EU centres. But the effects are unlikely to be universal.
As the UK commercial property market has started to stabilise and funds have started to reopen, it is important to remember that, despite the uncertainties created by the vote for Brexit, commercial property offers that most highly prized feature in the today’s markets: yield.
Where a fund has exposure to a diversified portfolio and is not heavily exposed to the uncertainties facing the London office market, with high quality tenants and with a long unexpired lease profile it would be wrong to eschew the asset class altogether.
But there is a lesson to be learned about the appropriateness of holding exposure to an illiquid asset class like property in open-ended fund structures, which may need to suspend daily dealing in periods of market stress or herd-like selling. As funds will be rebuilding their cash buffers, these are times when advisers should certainly weight up the merits of closed end property trusts.
Jason Hollands is managing director of communications and business Development of Tilney Bestinvest
Key points
Borrowing costs have reduced further following Brexit.
In the immediate aftermath of the vote there was a freezing up of many of the industry’s open-ended commercial property funds.
Despite the uncertainties created by the Brexit vote, commercial property offers yield.
