Flash Note

Carmignac Patrimoine: The upside of Brexit-led turbulence July 2016

29.07.2016

The environment seems to be relatively favorable in the short term but, one cannot ignore the political risks that are adding to the volatility that markets are facing.

Key Takeaways

  • In the short-term, the paradox of the Brexit vote is that it acts as an excuse for policy makers to become even more dovish, thereby offering renewed support for markets
  • However, there is still ample potential for economic and political situations to go awry
  • Notably reflationary policies could start to materially affect inflation expectations in the US
  • Our main convictions: high visibility stocks, cheap energy bonds and equities, European bank credit, sovereign peripheral bonds, selective EM debt
  • Our risk management: safe-haven currencies, gold stocks and an active management of our equity, rates and credit hedges.

  The overall environment for financial assets seems to be relatively favorable in the short term. Indeed, moderate growth, accommodative Central banks and soon more daring budgetary policies (UK and Japan first, and then possibly the US) make up a rather supportive cocktail for markets. However, one cannot ignore the political risks that are adding to the volatility that financial markets are facing (and will continue to face). Moreover, there is still ample potential for economic situation to go awry. These factors, along with historically high valuations, leave markets prone to short term spikes and dislocations.

In these market conditions, we aim to put our conviction driven, non-benchmarked philosophy combined with active risk management to work in order to successfully navigate these turbulent times.

In these market conditions, we aim to put our conviction driven, non-benchmarked philosophy combined with active risk management to work in order to successfully navigate these turbulent times.

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Balanced portfolio construction

Our overall strategy continues to be based on our main convictions (high visibility stocks, cheap energy bonds and equities, European bank credit, sovereign peripheral bonds, selective emerging debt) which should enable us to generate performance on the one hand, while balance these with safe-haven currencies, gold stocks and an active management of our equity, rates and credit hedges.

Balance between performance drivers and risk management. The investment strategy is a combination of our main convictions (high visibility stocks, cheap energy bonds and equities, European bank credit, sovereign peripheral bonds, selective emerging debt) with safe-haven currencies, gold stocks and an active management of our equity, rates and credit hedges

Performance drivers

High Visibility stocks - 29% of Carmignac Patrimoine *
Today’s uncertain economic and political climate maintains the appeal of non-cyclical stocks with good earnings visibility.

Our health care exposure is focused on highly innovative companies with a unique positioning in the most promising forms of treatment. One of our main healthcare convictions – and the first holding in our equity portfolio – is still Novo Nordisk, a leading company in insulin-based diabetes care.

The Technology and Internet sector now has more of a "winner takes all" dynamic where the dominant players are able to capture a very large share of the market opportunities. Carmignac’s investments within the sector focus on companies which we believe are able to create additional long term growth drivers by reaching out beyond their legacy business to new areas with high growth potential. Secular growers like Amazon and Facebook are good examples of firms able to deliver long term performance and to navigate in a weak global growth environment.

Energy stocks - 4% of Carmignac Patrimoine *
Today’s volatile markets are a source of new opportunities. This is particularly true of the energy industry, where plunging prices have offered an excellent entry point at the beginning of the year.

After investors’ capitulation, the brighter outlook of the oil sector has led us to a rigorous stock picking of high quality companies.

Corporate bonds

European Banks - 10% of Carmignac Patrimoine *
European bank credit should remain among our main performance generators. The de-leveraging and de-risking that the sector is witnessing (brought on by re-regulation of European banks) is set to continue and is a very supportive fundamental argument for the national champions within the financial credit segment.

Commodities - 3% of Carmignac Patrimoine *
Dislocations in asset classes (often characterized by important widening of spreads1 ) can lead to punctual opportunities. Indeed, violent widening of commodity credit spreads have led us at the beginning of the year to selectively invest in low-cost commodity fallen angel credit with a large margin of safety.

Sovereign bonds

Emerging sovereign debt - 6% of Carmignac Patrimoine *
With the dollar no longer strengthening, the Fed not aggressively moving in on rates and Chinese demand stabilising, carefully chosen allocation to emerging sovereign debt (primarily commodity driven) has enabled us to include cheap debt at interesting coupon yields, in particular in Brazil, Mexico and Argentina.

European peripheral sovereigns - 10% of Carmignac Patrimoine *
European peripheral sovereigns present a renewed opportunity, after the recent upwards moves caused by the “brexit issue”. The fact that the European Central Bank continues to buy bonds to the tune of € 80 bln a month (even € 85 bln in June) should support this asset class possibly, more so as the ECB will need to find a solution to the scarcity of German bonds eligible to asset purchases under current rules.

Risk management

If in the short term, Central banks activism should keep supporting markets; there is still ample potential for economic or political situations to go awry. In this context of high market instability, we will not hesitate to use all our risk management tools to actively manage our exposures to the various asset classes.

One of the current risks is the re-pricing of the Fed Funds futures (which has moved significantly lower). As a consequence, we believe that the short end of the US curves could rise. In this context, we aim to hold a long2 dollar strategy. Furthermore, the inflation risk in the US might be underestimated in particular if reflationary policies become a live theme in the upcoming electoral debate. We prefer to be positioned for a rise in US 10-year break-even inflation, buying US 10 year linkers and selling US 10 year nominal Treasury bonds. In addition, the resulting contraction in real yields is favorable for our gold exposure, which could also play its safe haven role in case of renewed market instability. We also hold targeted equity hedging strategies to focus on vulnerable themes and/or market segments, such as collateral victims of Amazon’s technological and retail strategies.

Alongside these specific risks, the market instability of the past few months has vindicated our investment philosophy of actively managing our level of equity/credit exposure and modified duration so as to protect our main performance drivers, according to where we see the market risk curve evolving.

1 Spreads: show the difference between the quoted rates of return between two different investment vehicles.
2 Long: (or long position) is the buying of a security such as a stock, commodity or currency
*Source: 15/07/2016

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