Potential headwinds caused by the impending EU referendum are enough to warrant holding higher-than-ever cash positions, according to David Coombs (pictured). 
The FE Alpha Manager, who is the head of multi-asset investments at Rathbones, says that he has been cautiously positioned since last year’s UK general election, when Cameron initially promised the public a ‘Brexit’ vote.
The impending referendum has been a hot topic of debate over the last year or so, with many UK investors switching their money out of domestic-facing small and mid-cap stocks and into larger global-facing companies.
Since the start of the year, in fact, the FTSE 100 index has more than doubled the returns of the FTSE 250, FTSE Small Cap and FTSE AIM 100 indices, despite smaller firms’ popularity in 2015.
Performance of indices in 2016
Source: FE Analytics
Other managers have reduced their UK stock exposure completely, with the likes of SWMC’s Brian Cullen warning FE Trustnet earlier in the year that an exit from the EU could prove hugely detrimental to the UK’s economy and market.
Coombs, though, says that many investors are missing the point when it comes to concerns regarding the referendum and argues that too many people are concentrating on the impact it will have on the UK alone without considering its impact on Europe.
“Let’s assume the ‘remain’ vote wins on June 23 and we stay part of the European Union. A lot of people think, ‘well that’s it, everything is fine’ and the markets seem to reflect that as well,” he said.
“However, I believe there are still serious issues around the euro and the European economy that haven’t gone away, whether it’s Greece, unemployment rates or a lack of growth across Europe, these problems are still in play.”
“There’s a reason why we have negative interest rates in Europe, it’s not just because of Brexit. I think everyone is so focused on the impact of a Brexit domestically here in the UK that they’re missing the point.”
Coombs says that negative interest rates have been put in place within Europe in order to offset a potential recession and, despite some investors branding the area as attractively-valued and on the road to recovery, says that the region is too high-risk to be positive on.
“People are getting excited about a recovery, but it’s a recovery from a very low base. European banks still don’t look to be in particularly good shape from what I can see,” he added.
The manager isn’t seeing a great deal of opportunities in the UK either, given the level of uncertainty in markets at the moment. The stocks he does own are very much global-facing and as such, the direct revenue he earns from the UK market is small.
What he deems to be particularly concerning is that market behaviour hasn’t reflected the potential headwinds that the referendum could cause, with the FTSE 100 ultimately flat-lining over the last fortnight.
Performance of index over 2weeks
Source: FE Analytics
“Markets seem to be relatively sanguine about the vote, which is surprising given the polls have narrowed - albeit the odds are still on for ‘remain’ to win,” Coombs continued.
“You might have thought there would be a little more volatility in the UK market and I’m surprised there hasn’t been. Yes the more domestic-facing stocks have underperformed versus some of the more international stocks in the index, but it makes me very nervous that the market just seems to be discounting a Brexit win and that’s caused slight concern.”
“All of these markets are struggling to accept what polls are saying because the consensus is that polls are rubbish now after what happened in the general election and they just ignore them.”
“The polls just might be right and I’m really nervous that the consensus is saying the polls are wrong and the equity market seems to be confirming that.”
The manager is also significantly underweight emerging markets at the moment, but this has been a long-term theme in his portfolio for a significant amount of time.
It isn’t just equities that the manager has concerns about, either. While his exposure to fixed income has stood his portfolios in good stead this year following their increase in popularity, he has been selling his UK gilts and high-grade corporates over the last week and argues that risk levels haven’t been priced into bond markets.
“I’ve had quite a lot of fixed income which has been really helpful this year but I’ve been selling it and taking profits on my AAAs and gilts,” he said.
“If we do leave on the 23rd, I suspect gilt yields will fall further and you’ll make more money from bonds, or certainly the quality end of the investment grade market. High yield could sell off.”
“I do think your AA-and-above bonds will rally because the Bank of England will be forced to announce emergency cuts in interest rates and may even announce further QE to flood the market with liquidity and that could mean yields fall a bit further over the first few days.”
“The trouble is, that’s a big bet to make and I’m not willing to do it – the risk that we stay in and yields rise quite quickly is too great for me. I’d rather hold cash at this level, especially seeing as there is more volatility in the bond market at the moment than there is in the equity market.”
Currently, Coombs’s Strategic Growth Portfolio – which has a “medium” risk mandate, holds 12 per cent in cash, while his Total Return Portfolio, his lowest risk fund, has a cash weighting of 18 per cent.
“I can’t remember these weightings being as high as this before in terms of a tactical allocation,” the manager said.
“It’s all about Brexit. Whenever you’re going into a market event that you know is going to happen, I like to have lots of liquidity.”
Despite his concerns over the EU referendum, the manager points out that there will still be opportunities in the market whether we leave or not, but says it will involve much more individual stock selection rather than opting for sectors or market themes.
Because of this, the manager has been reducing his exposure to funds and investment trusts recently in favour of individual holdings.
“There are certain areas of the economy that will do okay and there will be others that won’t. It will be much more dependent on the micro in terms of the UK index to see how much each company is impacted by a Brexit,” Coombs explained.
“A lot of company analysis will need to be done. A lot of that we don’t know yet because firstly, we don’t know which government will be in power and secondly, we don’t actually know what policies they will adopt to combat the stress of leaving.”
“It’s going to be incredibly complex and people are making very glib predictions when frankly it’s far too complex and nuanced to make these kinds of statements. I can see a route that looks okay and a route that looks disastrous - a lot of this depends on government action.”
Over five years, Coombs has outperformed his peer group composite by 11.53 percentage points with a total return of 27.03 per cent.
Performance of Coombs vs composite over 5yrs
Source: FE Analytics
