The UK’s vote to quit its membership of the European Union has made European financials “almost un-investable”, according to Artemis’ Jacob de Tusch-Lec, although the global equity income manager argues that other sectors could benefit from the consequences of the decision. 
De Tusch-Lec, who runs the £3bn Artemis Global Income fund, believes that a “long period of uncertainty” is on the cards after the surprise referendum results and the speedy realisation that neither the UK government nor European policymakers have a thought-out plan on what to do next.
While the manager thinks it is possible that the UK could ultimately benefit from leaving the EU by “fudging together a solution in typically British style”, the story could be a lot different for the rest of Europe.
“This is a political upheaval without precedent. The UK’s vote to leave may mark the start of the slow disintegration of the EU. The European project looks increasingly broken. If the UK leaves the EU, my native Denmark is likely to follow. In this sense, Brexit is a potential ‘game changer’,” he said.
“Given this uncertainty, it is understandable that the compensation the market demands to hold risky assets such as equities – the ‘risk premium’ – has risen dramatically. Safe-haven assets, such as government bonds and equities whose earnings are impervious to economic turmoil, are in demand. Value stocks (which trade on a lower multiple of their earnings than the market) are not.”
“The Artemis Global Income fund has a significant level of exposure to Europe. It also has a significant bias towards ‘value’. Both characteristics have been deeply unhelpful, more than offsetting the positive contribution from the fund’s stock picking and currency overlay (we have long taken the view that hedging away some of our currency risk using a short euro/long dollar currency hedge is a sensible precaution).”
Performance of fund vs sector and index over 3 months
Source: FE Analytics
The fund’s positioning has been “unhelpful”, de Tusch-Lec, concedes, as his base case was that the European economy could start to improve “in the absence of an exogenous shock”. However, the Brexit result has “delivered precisely that”.
In addition, the manager says that the sharp falls in some of his holdings appear to be well-founded. He highlights European banks and insurers as companies that could suffer if the less optimistic outlook for the continent means bond yields there remain stuck at record low or negative levels for a long time.
“Consider a European bank whose shares are trading on just 0.8x book value. That looks cheap under a scenario where there are realistic hopes that interest rates and bond yields might rise and the bank can earn a return on equity above its cost. But if a long period of zero or negative rates beckons, investors will inevitably start comparing European lenders to their peers in Japan, where we see multiples as low as 0.4x book value,” he said.
“Shares in some insurance companies have also fallen. Again, this may be with good reason. The losses may seem extreme. But if we look at the yield these companies can now expect to receive on their investment portfolios over the coming months and years, they may prove justified.”
Performance of index over 1yr
Source: FE Analytics
Because of these concerns – the manager says European financials “may now be almost un-investable” because of Brexit – Artemis Global Income has cut losses in Spanish bank Santander and Italian insurer UnipolSai.
De Tusch-Lec adds that his response to the Brexit result has been “measured” and he is not “reinventing the portfolio altogether”.
“Instead, we have been appraising our holdings and the wider market as rationally as possible,” he said. “And in some cases, the sell-off appears to be more about sentiment than fundamentals.”
Stating that he will not run away from assets that look too cheap and appear to have good prospects, he has maintained positions in European holdings such as Italian TV and telecoms ‘tower’ companies EI Towers and Rai Way.
He has even been adding to European stocks, in a highly selective manner. For example, he bought more of infrastructure group Ferrovial after its shares were treated too harshly; investors seem to be ignoring that a significant proportion of its revenues come from toll roads in Canada and it owns a stake in Heathrow Airport, he suggests.
“We are not selling out of Europe wholesale. We are hoping for a technical bounce and some policy action to calm markets in the short term. We will continue to use our currency overlay to hedge away some of our exposure to the euro (which may have further to fall). Fundamentally, however, there may be little that can be done in terms of a ‘quick fix’ for Europe. As painful as it is for us to admit, the outlook is far bleaker than we believed,” the manager concluded.
“Although we have reduced our exposure to European financials, the prospect of interest rates that are ‘lower for longer’ should be seen as an opportunity for many of our holdings – notably German real estate and some infrastructure stocks – rather than a threat. More broadly, this looks set to be another difficult summer for markets. So rather than taking extreme positions, we continue to proceed with caution.”
While Artemis Global Income is currently in the IA Global Equity Income sector’s bottom quartile on three-, six- and 12-month views, it is in the top quartile over three and five years. Since launch in September 2010, the fund has made a 121.14 per cent total return – which makes it the best performer in the peer and is significantly ahead of the benchmark’s gain.
Performance of fund vs sector and index since launch
Source: FE Analytics
Artemis Global Income has a clean ongoing charges figure (OCF) of 0.81 per cent and is yielding 3.62 per cent.
