Bye Bye UK

by Oddo BHF Asset Management

The British voted last night to leave the EU. The impact on financial markets has been massive, since they had come to anticipate a “Brimain” over the past few days.


§ The pound lost up to 11% vs the US dollar.  This collapse is driven by the current account deficit (-4.8% of the GDP) and uncertainties surrounding upcoming political changes. Once invoked article 50 of the Lisbon treaty gives the U.K. two years to negotiate new bilateral rules with the EU. The BoE will certainly  intervene in case of extreme market volatility. In the medium term, though, a 10% decline means a competitive devaluation as long as it does not affect the cost of the UK sovereign debt. This does not seem to be the case this morning with the 10yr UK government debt trading at around 1%.


§Nikkei drops 8%


§In Paris, the CAC future opens with a -11% loss and the Eurostoxx future with -12%


§The European High Yield market (Itraxx Crossover) widens north of 100bps


§Gold gains +5% whereas Oil (WTI) suffers 5% loss


Beyond these immediate reactions, however, we should bear in mind that the impact on European growth should be limited to around -0.2%. Furthermore, central banks and governments will  try to restore confidence.


How are we positioned?


We were cautious in our diversified portfolios with a reduced exposure to equities and high yield bonds. We held significant amounts of cash (over 10% on average) to stay flexible and be able to act quickly. We sold our UK exposure and hedged the GBP currency in order to preserve investors’ capital. We also hedged part of our peripheral exposure by selling futures contracts on Italian debt.


For example, we reduced our net European equity exposure of Oddo ProActif Europe  from 55% to 35%.  Within Oddo Patrimoine, equity exposure was lowered from 37% to 25% and we increased our duration with the purchase of Bund call options (positive impact of around 20 bps at the market open this morning). And we increased the cash bucket in Oddo Haut Rendement 2021.   


Risk & opportunities


The political risk is the most significant. Euro zone cohesion is at risk. As early as Sunday, Spanish general elections will be another test of the rise of populism and protectionism. From now on, financial markets will move in rhythm with elections and statements of the political leaders.


A 10% equity fall and a high yield spread widening may offer buying opportunities for investors ready to face high volatility in the short term. Emerging markets will fluctuate on the opposite side of the US dollar. No buying rush but targeted investment opportunities on pullbacks.


What will we do in our portfolios?


We will be mindful of analyzing the impacts of these parameters on our portfolios in the coming days. Global growth disillusions and uncertainties surrounding Europe stability will weigh on investor sentiment for some time.


We will keep our prudent positioning and stay highly selective in a market characterized  by volatility.


Equities: gradual reduction of our hedging positions starting with a -15% market decline and a selective repositioning based on our convictions.


European High Yield: gradual reduction of our hedging positions once itraxx crossover reaches 500bps and reinvestment of our liquidity bucket. We believe that the European high yield spread widening in an unchanged low default rate environment should provide new entry points for investors.


Currencies and commodities: On a short term horizon, the US dollar and the Japanese Yen will benefit from their safe heaven status. Gold should represent a diversification tool for investors allowed to consider such position.


In any case we favor liquid investments.



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