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Brexit Implications on Portfolio Construction

July 12, 2016

Brexit graphic

In light of the Brexit stir, those administering sovereign wealth funds, long-term institutional investors, and large pensions need to consider what types of economic uncertainties they may be facing. The next months and years will undoubtedly carry various uncertainties and uncharted territories for investors and shareholders alike.

The Brexit vote has forced investors to consider the following portfolio implications:

  • An initial slowdown of growth and lowering of investment activity, as investors may hesitate to make decisions due to uncertainty.
  • U.K. exporters will likely benefit from currency weaknesses, while U.K. importers will be facing higher costs.
  • Investor opinions of Europe may be compromised; many may be seeking more stable and attractive global opportunities.
  • Financial service companies that previously used London as a base in the U.K. may react by downsizing or relocating U.K. operations.
  • In efforts to combat inflation pressures, the Bank of England may consider raising interest rates. This in turn could affect other aspects such as mortgages and loans.

In the meantime, amid these uncertainties, certain board practices must be emphasized. Now more than ever, there is an increased need for client communication, shareholder engagement, and board transparency. The need for vigilance against securities fraud issues is also heightened during such times. As investors brace for a season of volatility, the focus on portfolio construction should also include increased diversification and increased communication between advisors.

McKinsey Report Indicates a Shift in Focus Towards Portfolio Construction

A recent report titled “From big to great: The world’s leading institutional investors forge ahead” provides useful information and insight regarding large investors’ plans to enhance their figures and performance. The report, issued by McKinsey & Co., surveyed 27 large pensions and SWFs, asking them to report on 7 key areas in which they plan to invest.     

The research data highlights two main points that are important to consider. First, leading institutional investors are seeking ways to integrate into true institutions through high-performing culture. Secondly (and perhaps most importantly), the majority of executives at SWF’s institutional investors are re-focusing more on portfolio construction.

The insights and information provided by the McKinsey Report arrive in a very timely fashion. Many of the main takeaways can help SWFs and large pension funds as they handle the long-term effects from the Brexit scenario.

Takeaways From the McKinsey Report

Senior partner and leader of McKinsey’s institutional investor practice, Sacha Ghai, stated that executives are concentrating their efforts on portfolio construction rather than simply “chasing alpha.” This is a return to what Ghai calls “the basics of investing” — building optimal portfolios and strengthening strategic asset allocations.

Various changes and adaptations accompany the increased focus on strategic asset allocations, such as:

  • Increases in staff members focused on strategic asset allocation
  • More frequent asset allocation studies and research
  • The need for the board of trustees at sovereign wealth funds and large pensions to be more actively involved

Other takeaways include:

  • More executive shifts toward liability awareness and liability-driven investing (LDI)
  • Senior executive teams should set annual research agendas based on themes and high-priority sectors (for instance, e-commerce, the Asian financial sector, cyber security issues)

Thus, the good news is that the study data indicates that many executive teams may already be well-equipped to deal with the expected volatility from the Brexit fallout. In particular, a focus on liability-driven investing may assist funds and pensions in anticipating and reacting to shifts in inflation and interest rates. By creating a realistic, balanced outlook, investors can create early warning mechanisms to help secure and protect their interests.

Trends in institutional investment practices correlate directly with concrete factors in the economy. The more that wealth funds and pension funds can develop an edge in understanding nuances occurring globally, the better chance they have at obtaining successful returns, as well as avoiding legal liability for disputes and conflicts.

If you have any questions or concerns regarding institutional investor legal issues, contact us today at Kessler Topaz. Our team of attorneys is dedicated to staying on the forefront of crucial factors that affect investor activity and shareholder rights.