Global equities
20 May 2016 | By Ian Heslop

Deep impact

It is of course a truism that nobody knows what the result of the UK’s European Union membership referendum will be.

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Do you think a vote for the UK to leave the EU would have a positive/negative/unclear impact on the UK stock market?

It is of course a truism that nobody knows what the result of the UK’s European Union membership referendum will be. Although the bookies’ odds on the outcome of the vote may be subject to almost constant fluctuation, the only certainty that we as fund managers can discern is that the run-up to the poll and the immediate aftermath will be characterised by high levels of financial market volatility.

Put another way, we know that equity markets are driven by a combination of fundamentals and sentiment. The uncertainty created by the looming vote on the UK’s continuing membership of the EU can only be negative for sentiment.

While the impact of the result of the referendum on the UK equity market is of course a matter of interest, the global nature of corporate earnings in the UK means that the effect of the vote is likely to be felt more widely.

Do you expect the UK to vote for Brexit?

This is inevitably a tricky question to answer for anyone not in possession of a fully functioning crystal ball. What we do know is that those on both sides of the debate have been making their cases with increasing passion.

On balance, I tend to agree with the view of a number of my UK equity colleagues, which is that the national psyche is too conservative (with a small ’c’) to vote in favour of a change of the magnitude in question. Statistically, there is also a greater likelihood of a referendum leading to a continuation of the status quo.

Nevertheless, while the question on the ballot paper – “Should the United Kingdom remain a member of the European Union or leave the European Union?” – seems to have a clear enough focus, there is a school of thought that the referendum on 23rd June has come to represent a much deeper debate about the winners and losers of globalisation. 

With increasing globalisation has come greater competition for jobs, and the virtual disappearance from mature economies of whole industries. For those who – rightly or wrongly – have found the process of globalisation to be an uncomfortable one, a “leave” vote in the EU membership referendum may be perceived as a way of registering displeasure.

If we accept that the outcome of the referendum has a greater significance than the UK’s continuing membership of the EU, the key question is to ask how far this kind of sentiment pervades; the answer may well be that globalisation-related dissatisfaction is a bigger motivating factor for supporters of the “vote leave” camp than some commentators have recognised. The scale of the present refugee crisis at Europe’s southern border, combined with relatively anaemic economic growth has served only to add fuel to the debate.

Whichever way you look at the continent as a whole, it’s hard to deny that Europe is currently enjoying a much greater level of stability than it did through much of the 20th Century. One school of thought is that the cost of this stability is the “pooling” of some sovereignty. Although the UK may have had a tendency in the past to “sit apart” from its neighbours in continental Europe, the realities of trade in a post-imperial environment have clearly changed the dynamic of the relationship.

Have you been making changes to your fund based on a potential exit even if it’s not your base case?

If not can you please briefly expand on the reasoning?

Our approach to investment is distinctive, in the sense that we are not in the business of making macro-economic forecasts. Rather, we measure how political risks such as the outcome of the referendum are being priced by the market – in other words, how the market is “filtering” the available information – with the result that we do not find ourselves constantly repositioning our portfolios in response to the result of the latest opinion poll.

In terms of our global investment approach, the European Union membership referendum is in essence no different from any other macro-economic or political risk, an obvious example at present being the outcome of the US presidential election.

Do you expect the EU to exist in a similar configuration to today in 10 years’ time?

Personally speaking, I expect the European Union to continue to exist in a form broadly similar to its present incarnation.

One of the greatest challenges facing the European Union is a perceived lack of political legitimacy, manifested for example in a widespread misperception that laws are passed by “unelected bureaucrats”. Setting aside the reality of low turnouts at European Parliamentary elections (they hit a record low of 42.54% at the 2014 vote), the challenge of the widespread misperception that laws are passed by unelected representatives does still pose a potentially existential threat to the European Union in its current state.

Similarly, I would be unsurprised if, at some stage in the coming decade, the Schengen Agreement – which led to the creation of Europe’s large borderless areas – were to be revisited in some way, probably leading to a greater degree of policing of Europe’s borders.

Do you expect the eurozone to exist in a similar configuration to today in 10 years’ time?

I believe that the eurozone was, to a degree, a somewhat idealised project, driven largely by political – rather than economic – ambition to bind nations together.

As I have said on a number of previous occasions, I have always been of the view that economic integration without fiscal integration was almost doomed to failure. There are clear challenges associated with applying the same rate of interest across different countries or regions with significantly different economic growth profiles, as is the case in the eurozone.

Indeed, a similar argument could be made for the different regions of the United Kingdom, where applying the same rate of interest across different parts of the country with wildly differing economic profiles only really succeeds as a result of internal fiscal transfers. Put another way, to be sustainable in the long term, I believe that similar fiscal transfers would be required within the eurozone. Clearly the appetite to do this in the present environment is likely to be severely diminished.

A plausible scenario, to my mind, would be for the euro to survive as the currency of a smaller number of Northern European countries, with the remainder of current eurozone member states reverting to a “new” version of their pre-currency union currencies.


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