An interview with Michael Browne, portfolio manager on the Legg Mason Martin Currie GF European Absolute Alpha Fund.
No-one can spot the precise moment when things began to deteriorate. But if you go back a year, we could see there were problems looming. There were big cuts in capital expenditure for the oil and gas industry and you could see this was going to have a nasty impact on GDP numbers. Of course, the lower oil price will help the consumer, but it will take a while to feed through. And markets have been vacillating between the positive impact of a lower oil price and the negative impact in terms corporate health.
Has the current volatility reached a peak or will we have to wait another quarter or two? I can’t honestly tell you, but it will work its way through the system at some stage this year.
We try and build flexibility into our approach and my job is to protect the capital of my investors. The first element of that is how much of the portfolio could we liquidate in a day. Can I get to cash, because cash at the end of the day is the one thing that will hold its value. We’re running about 75% of the portfolio today that we could take to cash tomorrow and it’s a really important way of protecting value. The second element of flexibility is built into both position size and the overall amount of our balance sheet that we’re using.
In good times, we can expand the balance sheet up to two times leverage to take advantage of an opportunity and a normal fund can’t do that. The flipside is we can also shrink our balance sheet down and have a negative net. So, if markets are falling, we can capture some of the profit that you take from a negative beta and, therefore, a negative market performance.
This flexibility helps us to protect the value of our investors’ money and secondly, enables us to take advantage of opportunities that we see, be it on the alpha or beta side.
There’s no real evidence to say it’s worked in terms of getting the banks to lend more money or getting more economic activity going. However, where it has worked brilliantly is saving the Italian Government from having huge interest costs and therefore blowing up its budget deficit. It’s also removed the pressure of them being perhaps forced to move out of the euro, as we saw in 2011. So QE has saved the Italian government, but has it really made us all run out and get a mortgage on a house if you happen to be German or French? No, it hasn’t, and therein lies the problem.
Monetary policy tends to be quite weak in terms of getting activity levels going. When I look at small corporates today and think about how they’re reacting to life, the one thing they don’t want to do after going through all the troubles of the last six or seven years is to borrow money. They don’t believe the banks are their friends anymore and so they’re going to maintain their cash levels and be very careful with them.
The polls are marginally in favour of staying in. On that basis, you don’t have to worry about anything. However, you do have to worry about the exit part of Brexit, and the thing that interests me is the way you go about doing that. You have to sit down with all the EU countries and negotiate an exit. And you know what, divorce is never painless. You may well find yourself getting a deal that is not the bed of roses that you thought it was going to be.
In this case, are the British public going to be asked a second time in two or three years’ time whether they still want to leave the EU? I think that’s what’s likely to happen. In which case, this vote, if you like, is a preamble to the bigger, more important vote. Of course, you won’t get any politicians telling you that there’s a second vote around the corner. They don’t like that. It’s not good for their image.
The impact of mass migration on Europe is an enormous question and, let’s face it, it’s as old as Europe itself. It’s a continent of migration and economically speaking, it’s a really big positive. We are lucky enough to get young, intelligent people who want to work, who want to get on, who want to create, who want to have a job and pay taxes, be it VAT or income tax. In the short term, of course, there’s the cost of housing people, giving them health services and even just giving them enough clothes and food to get through each particular day, and those costs are going to necessitate significant increases in Government expenditure.
The German Government is expected to spend between 0.6% and 0.8% of GDP this year and probably more next year on these sorts of costs. But in the medium to long-term, all the studies show the returns you get from migration is an enormous positive to your economy. Strong economies import labour and do well. After all, the Unites States is a country built on immigration.
I think 2016 is a really complicated year as we come to the end of one particular economic cycle involving raw materials and commodities. There’s going to be quite a lot of debt that needs restructuring. There’s going to be quite a lot of companies that get themselves into trouble, or who are already in trouble. And there’s going to be quite a lot of bad news in terms of the GDP. I think somewhere in the middle of this year we’re going to feel a little bit like someone using a Satnav that’s got them lost. The Satnav sounds very authoritative, but it hasn’t a clue where it’s going and that’s the point of maximum opportunity.
That’s where I think we can start looking at this this new cycle, focusing on the consumer, the biggest part of the economy. This is an area which we haven’t been focusing on as investors for a long time. It’s about how we move products and goods, and the change in the services the consumer wants. I think this is probably going to be, at least for Europe, the first post-industrial recovery, and in that case, we’re entering a very exciting new world.