Following the momentous Brexit vote on 23 June, below is the Investment Team’s assessment of the impact on our investment portfolio from recent market movements.
We estimate for our aggregate defined benefit (DB) schemes that both assets and liabilities have risen by single digit percentage points as of end June, with liabilities rising slightly more than assets. For defined contribution (DC) the impact is age dependent.
The overwhelming message at this point is: don’t panic.
Equity and currency markets largely behaved as we expected following a Brexit vote. The one uncertainty we faced was whether UK gilt yields would rise (overseas investors selling, threat of credit-rating downgrade) or fall (threat of UK recession). In the event, markets followed the latter path with both long-dated fixed interest and index-linked gilt yields falling and remaining at historic low levels since. It is this move that leads us to estimate that our DB liabilities have risen.
To compensate however, about 70% of our funded liability risk is hedged for interest rate movements, which means that our liability-hedging assets contribute an increase in assets equal to 70% of the liabilities increase. It is mainly for this reason that we estimate our overall asset value to have risen rather than fallen.
Equities: Falling stock markets always make headlines and this time is no different. The UK market fell sharply immediately after the vote but has since recovered a large part of these losses. However, UK equities represent less than 10% of our global equity portfolio. Overseas equities on average have also recovered most of the immediate losses after the vote, led by the US which represents c.50% of our global equity portfolio. Overall, our equities have decreased by low single digit percentage points as of the end of June.
Currencies: The above estimate reflects movements in local currency terms. Our assets, however, are priced in Sterling and the fall in the latter means that each unit of overseas currency is worth more in Sterling terms. Our exposures to US Dollar, Euro and Yen were only 50% hedged, meaning that Sterling weakness mitigated, and in some cases more than offset, asset price falls in local currencies. As of the end of June, Sterling is still notably weaker than immediately before the vote, meaning that we estimate our global equity portfolio in Sterling terms to be largely unchanged from 23 June.
Alternative assets: Assessing the impact on alternative assets is harder as we have less visibility on the idiosyncratic impact on this part of the portfolio. Indeed, for some illiquid assets, such as UK property, the impact on market valuations will only emerge after several weeks or even months. Based on assumptions about the broad relationship between equity markets and our alternative assets, we also estimate the latter to be so far largely unchanged. Getting greater visibility on this part of the portfolio will be a focus for the team throughout this coming week.
Aggregating these component parts means that we estimate DB assets across TPT to have risen by single digit percentage points.
The impact on DC members invested in our target date funds (TDFs) will be age-dependent. Younger members in longer-dated TDF vintages have over 80% of their fund in equities. We expect these to have followed the same path as described above. Of course younger members have a much longer investment time horizon, typically 25 years or more to retirement, plenty of time to make up for short-term losses.
Older members approaching retirement can expect their pots to have risen in value due to the higher weighting to bonds and cash over equities in their portfolios. Annuity prices however are linked to gilt yields, so any retiree planning to purchase an annuity is likely to have seen a fall in his/her income purchasing power.
As we continue to gather information from our investment managers, the overriding message is don’t panic. We can expect to see further volatility in the near future as markets continue to digest the consequences of Brexit. However we look to our asset managers to take advantage of any profitable opportunities that emerge.
In the coming weeks the media will speculate on the longer-term relationship between the UK and the EU, and the changing landscape for UK politics. It is important to stress that we run a globally diversified investment portfolio; the ability of our assets to generate healthy investment returns is not solely dependent on the UK economy. Instead it is how the global economy performs over the long-term that matters most. For now, rest assured that the Investment Team will continue to monitor the situation.
We have compiled some Brexit FAQs which can be found here
. Please search for 'Brexit' in the search bar and click on 'Brexit Q&A'.