As we trundle on in the aftermath of the Brexit result, the surprise, and perhaps shock for many analysts and investors has begun to be digested. Earth remains constant on its axis and the sun still rises. This event undoubtedly presents challenges to the European and UK funds industry. However, despite the wringing of hands and the barrage of press coverage, these challenges may not be as material as investors expect.
Risk off in June
The initial reaction of investors has been, unsurprisingly, a knee-jerk of considerable risk aversion. According to Thomson Reuters Lipper data, the pan-European mutual fund market suffered net outflows of over €20bn for June 2016.
It saw massive net inflows into Dublin-based money market funds, with some €14bn going into US dollar-denominated funds and €6bn into sterling-denominated funds. This came at the expense of European and global equities funds.
Considering the rough market conditions during the first half of 2016, it was not surprising that the assets under management in the pan-European mutual fund industry decreased from the record level of €8.88trn (as at December 31, 2015) to €8.76trn at the end of June 2016.
However, this decrease of €126.7bn has been mainly driven by the performance of the underlying markets (-€156.2bn), while net sales contributed net inflows of €29.5bn to the overall change in assets under management in the European fund industry. A smaller net inflow compared with previous years, but still positive.
Despite these flows figures, equity markets have been surprisingly buoyant. The MSCI World index in sterling has reached a five-year high. Short-term fund volatility for UK-domiciled funds has returned to pre-vote levels after almost doubling immediately after the vote outcome.
Of all the industries that have touch points to the ramifications of the Brexit outcome, the mutual funds industry is best placed to deal with such challenges.
For UK-domiciled funds net outflows for June 2016 were nearly £3bn, which might sound considerable. By contrast, in the China-induced summer wobble of last year the UK fund market suffered net outflows of £11bn.
In the oil price shock of January and February 2016 net outflows were nearly £16bn. Similarly, the recent short-term fund volatility spiked considerably last summer, only to return to a normalised level. The main difference with the Brexit-induced volatility has been the marked increase in gilt volatility, which is more unusual but this too has reduced.
Fund houses constantly deal with such contrasting market dynamics: outflows in a rising market, inflows in a falling market, and all combinations in between. For 2008 the European fund market experienced nearly €600bn of net outflows, but it collected some €200bn net for 2009.
The Greek crisis of 2011 resulted in €100bn of net outflows, but over €200bn net flowed in for 2012.
In any period of risk aversion, there are still asset allocation models that need to be populated. Discretionary fund managers in the UK are currently sitting on double-digit levels of cash. Their European counterparts are holding even higher levels. This cannot be justified for fee-paying clients. This money will need to flow somewhere and it will require investors to carefully consider their next steps, but consider it they will. Whether it goes into equities, bonds or property, what has gone out will have to come back in.
Fund houses are already inoculated
Certainly, Brexit has caused consternation and reveals a considerable set of unknowns. However, the global financial crisis of 2008 was considerably more material. It forged much of the change, which means groups having survived that particular maelstrom are now much better equipped to deal with a comparatively local event such as Brexit.
Consider what fund houses have had to endure in terms of myriad legislative reforms since 2009. Direct acronym-heavy touch points include: Mifid II, AML, KYC, EMIR Shareholdings. Indirectly, add Basel III, Solvency II, CRD, Dodd Frank, and AIFMD.
According to Thomson Reuters Risk & Regulatory Data Solutions, there were some 51,000 global regulatory updates in 2015 for groups to contend with. Then you can throw in RDR reforms, the list goes on.
Whatever comes of Brexit in the years ahead will be small fry in relation to provisions with which the fund groups will have already had to contend post the global financial crisis.
Many UK-based fund groups will also have been inoculated by the Scottish referendum of 2014. This forced them to examine potential multi-region domiciles and operational bases.
Many fund groups may not have changed anything as a result of the Scottish vote, but they will have the existing compliance blueprints in place which are perfectly adaptable in the current environment.
Finally, fund houses across all domiciles have been getting fitter through the competition of a truly global and multi-faceted industry. Fee compression has forced innovation, the passive industry has forced innovation and increasing levels of investor consumer sovereignty has forced innovation. Fund groups today are lean having already been forced to trim non-performing aspects of their businesses.
Impact on product development
The Brexit result will potentially see a short slowdown of new launch development. Fund groups might take stock of product development and re-consider their strategic options.
Examining the 350 or so UK-domiciled fund launches year-to-date 2016, a significant proportion have been absolute return offerings. This reflects one particular success story of recent times. In the 12 months to May 2016, these products collected more than £7bn in net inflows. Ironically the recent performance of this aggregate product group has been less than stellar and this may now be a saturated market.
In a “lower for longer” rates environment fund groups need to ensure they can meet demand for income. The funds flocking to Dublin-based money market funds in June will not want to stay there for long. Analysis of provisional fund flows data for July suggests that bond funds appear to be benefiting already from some of the cash swilling about. The thirst for yield remains unquenched.
Opportunities always knock
As we sit here in the UK it is easy to overstate the effects of what is undoubtedly a major democratic consequence. But in context, Brexit is a local, rather than a global, event. Even as fund volatility spiked in the days after 23 June, you could buy or sell whatever securities you wanted in whatever quantities you wanted. Even commercial property funds (not all of which suspended trading) have begun to re-open with many now seeing the potential opportunities lower sterling might reveal.
The managed funds industry is dynamic, innovative, and far more resilient than a local geopolitical event. June European fund flows do not paint a particularly pretty picture and there might be more to come. But the financial services industry has experienced much, much worse before. Opportunities exist in all markets and that is why our industry remains such an exciting and vigorous one.
Brexit was a big shock, but it is a local, rather than global, event. The fund industry is resilient enough to withstand the challenges it brings despite initial outflows.