Q: What impacts will Brexit have on fixed income investors in the US? Finding yield and total return was a challenge before Brexit, now as an advisor, I feel it’s even more important to re-evaluate my clients’ fixed income allocations.
A: Great question. Going into the vote, our view was that Britain would stay. Well, we were obviously wrong, and as you stated in your question, our risk management process led us to re-evaluate the risk / reward dynamics in the market post-Brexit as well. Given that we are focused on absolute return solutions within fixed income and income producing assets, risk management is a key element of our investment process.
In our view, while Britain’s decision to leave the EU certainly indicates a changing macro landscape, what doesn’t change is that investors still need yield. The question now becomes what risks will they be willing to take in order to generate that yield? We believe the post-Brexit environment is generally more risk-off versus risk-on. As such, here are some considerations for advisors who are re-evaluating their fixed income allocation:
- Spend time on credit risk management. High yield is the most volatile US fixed income asset class; consider reassessing high-yield positions because of the greater uncertainty around Brexit, as well as currency fluctuations and their impact on global trade which will generally lead to more volatility in risky assets.
- Spend time on interest rate risk management. Analyze your duration exposure. At Bramshill, we will continue to buy longer duration A and AA rated corporates as spreads are widening out. These areas of the market in a high-quality credit will hold up well in this environment and will be sought after by investors who need yield. The reason is that as Treasury yields compress, pension funds, insurance companies and sovereign wealth funds, in particular, look to incrementally search for yield in safe havens with minimal credit risk.
- Reallocate capital and/or reinvest cash allocation. If you have cash on the sidelines, consider putting it to work strategically. There will likely be lower prices in the months ahead and strong entry points through-out the summer and fall. Although we have seen a recovery in the markets since Brexit, there are likely uncertain outcomes which are not being factored at this time. For example, how will Europe treat Britain in negotiations for its exit? How will the Italian banks be recapitalized? Will there be a drag on US and global growth from the uncertainty of this European situation.
- Continue your top-down research and macro analysis. In our opinion, the biggest concern going forward is the Italian referendum in October. If the Italian referendum on tax reform fails, it likely signals further discontent in another key member of the Eurozone. Italy has signaled a willingness to go to extreme measures such as backstop bank bond holders and even to leave the Euro and move to its own currency. Italian politics has historically been a wildcard. There are many uncertain outcomes with regard to their situation.
Art DeGaetano is the Founder and CIO at Bramshill Investments. Click here to view his bio and other team members of Bramshill Investments.
