Just over four weeks after Britain’s fateful vote to leave the EU, four leading UK alternative asset managers meet in London to reflect on the implications of Brexit for their businesses – both in the here-and-now, and also in the long run. The discussion begins with an exchange about what it was like to wake up to the news that the Leave campaign had won the day, and it becomes apparent very quickly that everyone had more or less the same experience: namely, that of a nasty surprise.
LIKE LEHMAN FALLING
“Shock and disbelief, with a capital ’S’ and a capital ‘D’” is how George Anson describes the prevailing sentiment in the St James’s offices of private equity investors HarbourVest on the morning of 24 June. At the City headquarters of Hermes Investment Management, meanwhile, the mood was “sombre” and infrastructure partner Hamish de Run recalls having a sense of the immediate aftermath of the referendum feeling like one of those rare moments in one’s professional life where it is instantly clear that something significant has occurred, “like Lehman falling or 9/11”, without it being clear at all what is going to happen next.
Some 920km away, Allianz Capital Partners’ Michael Lindauer had gone to bed in Munich the night before without much doubt that the British bookmakers’ prediction of a Remain victory would be proved right, only to rise in the morning and discover that they too had been wrong-footed, along with so many others. He says: “Ours was obviously more of an observer’s position, but it was very strange emotionally because for the whole of my life the UK has been part of the EU. And on that first morning, it was looking like this really would be a black Friday in the public markets and also the currency markets.” Thankfully as the day wore on, prospects of an instant Armageddon were dimming quickly, giving way instead to that profound sense of long-term uncertainty which has not lifted since.
Of the four men around the table, the one who had the most tangible all-hands-on-deck challenge to deal with on the Friday is Tony Brown of M&G Real Estate. Within minutes of the London market opening, listed UK house builders were getting hit hard, as were the REITs. Pricing in the direct real estate market taking a knock-on effect was inevitable, and M&G, managers of Britain’s largest daily liquidity retail property fund in Britain, moved quickly to implement the contingency plan Brown and his team had spent weeks and months drawing up in preparation. “We didn’t expect the result either, but it’s just as well that we were ready for it. The first thing was that we had already agreed to produce a new valuation on the 24th, which you wouldn’t normally do for a monthly valued fund, and subsequently to value the fund more regularly than usual. On that morning, it seemed quite difficult to know how bad it was going to be, and to get a handle on quite how far it might go. Now, a month on, it is much clearer where we are, but at the time it seemed very difficult to assess the level of market volatility and impact we were going to have.”
On 5 July, in a move similar to those taken by other large UK property managers, M&G imposed a temporary suspension of trading in the £4 billion ($5.3 billion; €4.6 billion) M&G Property Portfolio and its feeder fund. At the time of this article going to press, the suspension remained in place.
By contrast, in the more slow-moving worlds of private equity and unlisted infrastructure the immediate priorities arising from the wreckage of Remain’s defeat did not relate directly to protecting the underlying investment portfolios. Valuations in these asset classes do not change on a daily basis, and for global private equity fund investors such as Allianz and HarbourVest, political upheaval in Britain, while obviously significant, ultimately represents a local difficulty.
For Anson at HarbourVest, the first order of business was to engage with the team in London, where the firm has its sole European office. The employees there include 10 administrative staff, who are all British, whereas of the 26 executives, only nine carry a British passport. Says Anson: “They come from all over Europe and outside Europe as well, so for them personally there really are now some serious questions around what’s going to happen with their residency status. From a business point of view, therefore, it was as much about signalling to our London employees that things would continue as normal, as it was about reassuring our investors that the sky wasn’t falling in.”
The majority of HarbourVest’s funds are being managed out of the firm’s Boston main office, so only its AIFMD-compliant programmes that are domiciled in the UK might be affected by any Brexit-driven regulatory change in the future. For the time being, the firm’s commitment to London as its European headquarters remains firm, although Anson also notes that there is as yet no clarity around whether the firm may need to open another office elsewhere in Europe before Brexit completes. “It would only make sense in respect of being AIFMD-compliant for our European investors, and it would have to be in an EU jurisdiction. Going to Switzerland wouldn’t solve anything for us, and it can’t just be a nameplate in Luxembourg either – we would need to have a genuine presence.”
De Run at Hermes also highlights the internal people management issue as an instant priority for his firm on 24 June, as well as giving assurances to the group’s investor base the week after. With most of the assets in the group’s £4 billion infrastructure portfolio located in Britain, it was important to remind clients that a UK recession resulting from Brexit, were it to materialise, would only have a minor effect on performance, due to the inherently limited correlation between user demand and GDP. Furthermore, with sterling’s sharp depreciation now effectively importing inflation, there is likely going to be a positive impact on the valuation of RPI-linked infrastructure assets as well – “somewhat perversely”, as de Run finds.
Yet another positive for de Run’s investors to bear in mind are UK infrastructure’s safe-haven characteristics, especially in the core segment where the assets tend to be regulated and the cashflows often contracted. Listed funds, for example, have seen their valuations rising sharply after the vote, as retail capital in search of shelter pushed in. And as de Run has found, institutional interest has also remained strong: “I was in Asia shortly after the referendum talking to investors and they still think the UK is a very attractive investment jurisdiction. They just wish to see what they consider a micro issue to go away so that they can go back to business as usual. There’s still a lot of demand from them; they think the framework is still solid.”
CONTRARIANS TO THE FORE
‘Business as usual’ is a theme that also resonates with Lindauer at Allianz. To invest in private equity funds is to invest for the long term; timing the market is nigh on impossible. Lindauer is philosophical about what it means to be pragmatic in his asset class: “We have to admit what we don’t know, and we simply do not know what’s going to happen in the political arena over the next 10 years, which is the relevant time period when we commit to a fund. That’s why we try to run a diversified portfolio, with basic target allocations of one third in Europe, one third in the Americas and one third in Asia, and so hopefully, with diversification over time and over different strategies also, this should help us sustain any shocks that occur in parts of the portfolio. This is how we invest, and it’s difficult to do much more than that.”
That being said, Lindauer is now also keen to see how some of the “more contrarian” GPs in his fund portfolio are going to react to the abrupt change in circumstances in the European market. These are managers chosen specifically for their ability to source “quirky situations” as the German puts it, the implication being that a market dislocation caused by Brexit is likely to create opportunities to buy well.
Now that the initial consternation has passed, there is a clear consensus around the table that, unlike in 2008, the current scenario does not hold much risk of systemic market failure. The global financial system is looking more resilient, with abundant liquidity being an obvious difference to the global financial crisis. By and large, the banks are open for business, some regional concerns such as in Italy notwithstanding. Everyone in the room has seen transactions in their sector stalling or getting pulled altogether as a result of Britain’s vote, but as Brown notes in the context of UK property: “There is still a functioning market, quiet but functioning, with clear differences in the reactions to different types of property.”
Plus, the UK market had been cooling even before the vote, and M&G, having spent the past year selling assets deliberately in order to take advantage of high valuations, is now intent on changing course, starting to buy in those segments where pricing has come off and in so doing re-weighting the portfolio once again. Selling is now firmly off the agenda: “We’re getting a huge number of calls from people saying can we help you with some sales, to which I politely say ‘we’re fine thanks’. There’s not really any distress around. The market has fallen a bit, yes, but it’s not significant.”
DON’T CHANGE YOUR PRICING MODEL
Even more emphatic on the current environment providing scope for putting fresh capital to work is Anson. He thinks it is now a good time for applying what has been the firm’s key learning from the post-Lehman experience in 2009: to stick to its convictions on pricing and to the strategy employed over multiple cycles. Back then, he recalls candidly about the firm’s global financial crisis tactics in its secondaries business: “With the benefit of hindsight, we should have loaded up on anything that moved and we didn’t. And the reason we didn’t was because we changed our pricing model to deal with the uncertainty and the risk that people saw in the market place, when actually the underlying assets we were buying were pretty much the same. But the emotional reaction from everybody was: ‘We don’t know what’s around the corner from here, Lehman has gone down, what’s next, so therefore rather than looking to make 2 times our money we’ve got to make 2.5 times’. So you bid a lower price, the vendor says no, you don’t get the deal. In fact, we should have just hit the bid, bought everything that was out there, and we’d look like heroes today.”
Instead, the firm completed just about $200 million worth of secondaries transactions in 2009, “woefully” undershooting its long-term average of $750 million to $1 billion. “Back then it seemed like a rational thing to do. But the quality of the asset hadn’t changed, and so we made it harder on ourselves to execute our business model,” Anson concludes.
Lindauer agrees wholeheartedly: “It’s the quality of the asset that matters more than anything.”
In addition to buyers holding their nerve, however, at some point the markets will also need some astute political decision-making to happen if a long Brexit-fuelled hiatus is to be prevented. De Run illustrates the requirement thus: “Talking to potential new clients, who are thinking about investing in UK infrastructure, has been interesting. In the week after the referendum, people used the excuse of there not being a prime minister and a government. The political response to that turned out to be quick, so that was the first tick, but now we hear: ‘Well, we don’t know when Article 50 is going to be triggered’. Some of the pieces of the puzzle need to be laid out, otherwise investors may not come back as quickly as we would hope. The longer it takes, there is a risk that people will switch off because they can’t get a handle on the political uncertainty affecting the UK and Europe.”
Lindauer adds: “Brexit is a process, not an event, there is no precedent for it, and the longer the uncertainty lasts, the worse it is for the market. Our base case, and there’s obviously hope involved, would still be that in the end there will be a bilateral trade agreement forming the foundation of a good ongoing relationship, because anything else would obviously be a lose-lose situation. And there will be some uncertainties and some problems along the way towards arriving at this.”
GLOBAL MARKETS WON’T RETREAT
On this balanced note, the conversation turns to the growing significance of political risk in markets globally, including its apparent increase in some of the world’s most advanced and hitherto stable economies. Must populist pushing of a protectionist, anti-globalisation agenda now be seen as a genuine threat to capital flowing freely between markets?
The roundtable participants do not believe so and speak optimistically about this aspect of the future. Brown’s view is this: “I think the trend towards global investment is unrelenting. Political sen-timent around the world is moving against that a bit, and a lot of it relates back to the financial crisis, but I don’t sense that it’s going to gain momentum, there isn’t enough support behind it. And the capital markets are so well entrenched now and so intertwined, I think it would almost be impossible to reverse, even if politicians did want to try.”
For de Run, the likelihood is that economic common sense will prevail. Using infrastructure financing in post-Brexit Britain as an example, he says: “There’s no way that the UK is going to enforce any kind of protectionism, least of all on the infrastructure side. It cannot afford to. In fact, we feel like it’s going to have to swing towards an even more investor-friendly scenario, simply because the country needs a significant upgrade of its infrastructure. UK infrastructure needs £200 billion over the next ten years, and with its fragmented pension system and a savings rate of one or two percent, unless there’s a step change in the way we save in this country, the funding will need to come from elsewhere.”
Neither will international investors want to turn their backs on Britain, as Lindauer asserts. In private equity, the country accounts for approximately a third of the European market, and the asset class is widely recognised as a well-established funding instrument for entrepreneurs. ”We think this is here to stay,” says Lindauer. “We definitely would like to continue to invest.”