When the AAC met, the risk of “Brexit” was still just that—a risk. In fact, outside of the currency markets, where one-month implied volatility for GBP/USD was trading at three-times normal levels, the forthcoming referendum was having little effect. U.K. equities and Gilts had been performing relatively strongly, in fact. Bookmakers’ odds put the probability of a “Brexit” at just 25-30%. Over the next few days, however, opinion polls showing substantial momentum for the “Leave” campaign caused turmoil across all markets, culminating in a sell-off on the day of the result.
How can one manage political risks such as this and the coming U.S. presidential election? And can the current political climate tell us anything about the long-term prospects for growth and market performance? These were key topics of discussion at the meeting.
At his first appearance on the AAC, our Head of Global Currency, Ugo Lancioni, acknowledged the difficulty of finding cost-effective hedges against political events. He noted that buyers of protection against sterling downside were paying extremely high premiums. Additionally, the demand for proxy hedging had also been strong, with substantial risk premia already obvious in many safe haven currencies like the yen and the Swiss franc. His preference had been to buy sterling on dips to capitalize on the “Brexit” premium, but moving closer to the vote he was favoring positioning as neutral as possible to the result—while conceding that post-vote currency correlations may be unpredictable.
Ugo did suggest that there might be more cost-effective hedges available in other markets, precisely because the risk seemed mainly priced into currencies. Thanos Bardas, our Head of Global Rates, felt that positioning in U.K. markets would be unwise because of sheer uncertainty about what a “Leave” vote would mean for the short-term health of the U.K. economy. Indeed, like Ugo he favored a neutral position relative to the referendum vote. As a hedge, he favored looking outside of the U.K. markets for trades with positive convexity and carry, such as a long in U.S. Treasuries versus a short in French government bonds.
The same challenges face investors anticipating the U.S. presidential election in four months’ time: finding opportunities that can deliver a target risk exposure but have not been bid up beyond a target budget by other investors.
But there is a long-term aspect to all of this as well as an event risk. After all, the U.K.’s decision to hold a referendum in the first place was not the result of some accidental slip of a civil servant’s pen. It came as a result of many years of growing populism, anti-EU and anti-globalization sentiment, exacerbated by the 2007–08 financial crisis and its economic consequences. And these forces are not confined to Europe, as the spectacle of the U.S. presidential primaries made clear: the two presumptive candidates for U.S. president are the most skeptical about trade in living memory—a point made by former Treasury Secretary Hank Paulson to Brad Tank in an exclusive interview at our CIO Summit in June.
Some AAC members observed that we have come to this point because policy since the financial crisis—specifically ultra-loose monetary policy and bail-outs without serious economic and market reform—is perceived to have favored large, multinational companies, and especially those with weaker balance sheets, at the expense of the broader middle class or the economy as a whole.
For these AAC members, the good times for large companies probably peaked along with U.S. corporate profits in mid-2014. Regardless of which candidate ultimately becomes U.S. president, the populist impulse has dragged them into anti-globalization and anti-trade positions; and while checks and balances are valuable in curtailing those instincts, even these have curdled into a highly partisan, no-compromise style of politics that does not bode well for the tax, fiscal and market reforms and infrastructure spending that the economy needs.
This turn to populism is a widely-recognized trend. It isn’t news to financial markets. But as “Brexit” reminded us, specific events within that trend certainly can be news. Preparing for them cost-effectively is difficult, but in the current environment portfolio managers should give it serious thought.
About the Asset Allocation Committee
Neuberger Berman’s Asset Allocation Committee meets every quarter to poll its members on their outlook for the next 12 months on each of the asset classes noted and, through debate and discussion, to refine our market outlook. The panel covers the gamut of investments and markets, bringing together diverse industry knowledge, with an average of 25 years of experience.
Committee Members
President and Chief Investment Officer
Portfolio Manager, Head of Global Rates
Alan H. Dorsey, CFA
Chief Risk Officer
Richard Gardiner
Head of Investment Strategy Group,
Chief Investment Officer—Neuberger Berman Trust Company
Head of Multi-Asset Class Portfolio Management
Chief Investment Officer—Multi-Asset Class
Co-Head, NB Alternative Investment Management
Head of Global Currency
Head of the Quantitative Investment Group, Director of Research
Chief Investment Officer—Fixed Income
Global Head of Alternatives
This material is provided for informational purposes only and nothing herein constitutes investment, legal, accounting or tax advice, or a recommendation to buy, sell or hold a security. Information is obtained from sources deemed reliable, but there is no representation or warranty as to its accuracy, completeness or reliability. All information is current as of the date of this material and is subject to change without notice. Any views or opinions expressed may not reflect those of the firm as a whole.
Neuberger Berman products and services may not be available in all jurisdictions or to all client types. Investing entails risks, including possible loss of principal. Investments in hedge funds and private equity are speculative and involve a higher degree of risk than more traditional investments. Investments in hedge funds and private equity are intended for sophisticated investors only. Indexes are unmanaged and are not available for direct investment. Past performance is no guarantee of future results.
The views expressed herein are generally those of Neuberger Berman’s Asset Allocation Committee which comprises professionals across multiple disciplines, including equity and fixed income strategists and portfolio managers. The Asset Allocation Committee reviews and sets long-term asset allocation models, establishes preferred near-term tactical asset class allocations and, upon request, reviews asset allocations for large diversified mandates and makes client-specific asset allocation recommendations. The views and recommendations of the Asset Allocation Committee may not reflect the views of the firm as a whole and Neuberger Berman advisors and portfolio managers may recommend or take contrary positions to the views and recommendation of the Asset Allocation Committee. The Asset Allocation Committee views do not constitute a prediction or projection of future events or future market behavior. This material may include estimates, outlooks, projections and other “forward-looking statements.” Due to a variety of factors, actual events or market behavior may differ significantly from any views expressed.
A bond’s value may fluctuate based on interest rates, market conditions, credit quality and other factors. You may have a gain or a loss if you sell your bonds prior to maturity. Of course, bonds are subject to the credit risk of the issuer. If sold prior to maturity, municipal securities are subject to gain/losses based on the level of interest rates, market conditions and the credit quality of the issuer. Income may be subject to the alternative minimum tax (AMT) and/or state and local taxes, based on the investor’s state of residence. High-yield bonds, also known as “junk bonds,” are considered speculative and carry a greater risk of default than investment-grade bonds. Their market value tends to be more volatile than investment-grade bonds and may fluctuate based on interest rates, market conditions, credit quality, political events, currency devaluation and other factors. High Yield Bonds are not suitable for all investors and the risks of these bonds should be weighed against the potential rewards. Neither Neuberger Berman nor its employees provide tax or legal advice. You should contact a tax advisor regarding the suitability of tax-exempt investments in your portfolio. Government Bonds and Treasury Bills are backed by the full faith and credit of the United States Government as to the timely payment of principal and interest. Investing in the stocks of even the largest companies involves all the risks of stock market investing, including the risk that they may lose value due to overall market or economic conditions. Small- and mid-capitalization stocks are more vulnerable to financial risks and other risks than stocks of larger companies. They also trade less frequently and in lower volume than larger company stocks, so their market prices tend to be more volatile. Investing in foreign securities involves greater risks than investing in securities of U.S. issuers, including currency fluctuations, interest rates, potential political instability, restrictions on foreign investors, less regulation and less market liquidity. The sale or purchase of commodities is usually carried out through futures contracts or options on futures, which involve significant risks, such as volatility in price, high leverage and illiquidity.
This material is being issued on a limited basis through various global subsidiaries and affiliates of Neuberger Berman Group LLC. Please visit www.nb.com/disclosure-global-communications for the specific entities and jurisdictional limitations and restrictions.
The “Neuberger Berman” name and logo are registered service marks of Neuberger Berman Group LLC.
© 2009-2016 Neuberger Berman LLC. | All rights reserved
