FE Trustnet News and Research

Elston: The three major mistakes investors must not make following the Brexit rally
Jonathan Jones
By Jonathan Jones  26 Aug 2016

Peter Elston, co-manager of the Seneca Global Income & Growth Trust, says that investors must not fall into the trap of making consensual trades after the recent snap rally.

Investors must not make the mistake of selling struggling UK mid-caps, buying rallying government bonds and adding foreign currency exposure to their portfolios following the Brexit-induced rally, according to Seneca’s Peter Elston

Brexit has changed nothing for Elston (pictured), co-manager of the Seneca Global Income & Growth Trust and chief investment officer at Seneca Investment Managers, who remains focused on his strategy despite it coming under pressure in the aftermath of the vote.

In the immediate fall-out of the EU referendum, shares in UK firms were in freefall, with the FTSE All Share plummeting more than 7.5 per cent.

However, things have picked up since, with the index rising impressively in the following months, and is now more than 7.5 per cent higher than pre-Brexit levels.

Since the vote, the global equity income sector has performed even better, rising 4 per cent the day after the referendum, and it has returned 13.37 per cent over the period, as the graph below shows.

Performance vs sector and FTSE All Share since the EU referendum


Source: FE Analytics

Meanwhile, Elston’s four crown-rated Seneca Global Income & Growth Trust has struggled, returning less than both (7.34 per cent) landing it seventh among its peer group out of nine.

Indeed, over three months the £61.5m fund is in the bottom quartile, but Elston says he is not concerned by this as the fund focuses on value, and as such, must take a long-term view.

“Yes you can have these short term events that affect performance but as a value investor you just have to buy things with a long term perspective and ride out any short term difficulties that you face.”

Still, with the fund underperforming its peers in the short term, Elston says the reason for this has been threefold.

“There were three reasons why we slipped down the peer group rankings – firstly we have this focus on mid-caps which underperformed in the days following Brexit,” he said.

Performance of indices since the EU referendum


Source: FE Analytics

In the day after the vote, the FTSE 250 tumbled 13.65 per cent, almost double its large cap rival.

There have been two drivers behind this trend. Firstly, given mid-caps tend to be more domestically facing than large-caps, investors have been concerned about how Brexit will affect the UK economy. Secondly, and more importantly, the more international-facing FTSE 100 index has been the prime beneficiary of sterling’s significant declines.

As such, the FTSE 250 is now only 3.52 per cent ahead of pre-Brexit levels, compared to the FTSE 100’s 8.67 per cent rise.

Elston’s fund meanwhile has a large allocation to mid-caps, with the likes of Victrex, Ashmore, International Personal Finance and National Express among its largest UK equity holdings.

“Mid-caps don’t tend to have the overseas earnings that the large caps have and they are generally perceived as being a bit riskier, so they significantly underperformed in the days following Brexit.”

However, despite this dip, over the longer term mid-caps tend to outperform large caps, as the above graph shows.

“Mid-caps – not just the UK but pretty much any market you look at – tend to do better than large caps because they have more potential to grow,” he said.

Despite the impact of the vote, Elston’s fund has not made loss in absolute terms but has slid relative to the peer group.

However, Elston says he still believes that mid-caps are the right area of the market to be in over the long-term.

“We think in a low growth world - and we may be looking at low growth for many years to come - as an investor you have to find ways and bits of the equity market that have a better chance of producing decent returns and mid-caps is one of those areas”

“Mid-caps don’t tend to do well in recessions but they tend to recover very quickly so that underperformance is short and sharp but as long as you are aware that you can have these short term periods of underperformance you should be okay,” he said.

The second position to impact the fund has been its lack of exposure to government bonds, which have rallied in recent times.

“A year ago we thought they were expensive. On long term real gilt yields of -1 per cent it means that you’re guaranteed to lose money if you buy them and hold them until maturity,” Elston said.

Performance of gilts over 3yrs


Source: FE Analytics

“However they’ve gone from being expensive to being even more expensive,” Elston said, and the graph proves this, with 10-year UK gilt yields having dropped 74 per cent over three years to their current low levels of 0.55 per cent.

“The strong performance of gilts has hurt us as well but we do think that [not buying gilts] is the right position to have – absolutely – because with those negative real yields you are guaranteed to lose money if you hold them to maturity.”

The third area that has impacted the fund is its lack of exposure to foreign currency compared to the rest of its peer group, Elston says.

The pound plummeted in the aftermath of the Brexit vote, and has struggled to regain much ground over the recent months.

Performance of sterling vs US Dollar since Brexit


Source: FE Analytics

Initially dropping 7.6 per cent against the dollar on the Friday after the vote, sterling has continued to fall, and is currently 11 per cent weaker than before the referendum.

However, Elston says that “foreign currency on the whole adds a lot of risk to the portfolio but like precious metals does not add a lot in the way of return.”

“So again we think that lower exposure to foreign currency is a sensible position to have for investors in the income fund who are probably in retirement and shouldn’t be taking those sorts of risks.”

While some have changed their strategies, others, like Elston, have remained steadfast in their strategy, and he says that while it is prudent to constantly revise a portfolio, short-term impacts like Brexit do not affect the long-term investor.

“Yes you should continually question your reason for investing in something but for us Brexit changed nothing at all. These are three positions that we think are very sensible ones even though they hurt us in the days following Brexit.”

FE Trustnet Registration