Brexit: a word that strikes fear into investors all around the world. It is particularly significant if you visit London and you talk to investors and investment managers in the Central London marketplace, which has become a real global hub of financial services and investment management around the world.
Now, what they'll say is, over in Britain, is you only want someone with a British accent sharing and talking about Brexit if you really want to know the facts. I don't think that's exactly right. I think what's most important is having someone who's on the ground and who has access and contacts that allow them to understand the situation at a much deeper level, and understands the impact that it has on investors, not just in Europe, not just in the United Kingdom, but in North America, as well.
I had the opportunity on a recent trip to London to sit down and speak with one of those individuals who specialized in politics and economics his entire life. David Riley is the partner and Chief Investment Strategist at BlueBay Asset Management in London. He is extremely well-connected into what's going on inside government and politics in London and throughout the UK and Europe, and he had a real interesting angle in discussing Brexit and the possible implications for all investors around the world.
I hope you enjoy it. David, welcome to Personally Invested.
David, welcome to Personally Invested.
Thank you very much. Looking forward to it.
It's great to have you here. Now, unfortunately, because of the format, what people can't see, we've just been discussing that you were on Bloomberg Television this morning - which is, again, reflective of your status in the industry, which we'll get to in a moment - but you still have your makeup on...
They did. They powdered me quite a lot, actually. And listeners, if they do see a photo as to this podcast, will understand why: my head can be quite reflective in the TV studio lights. That sort of thing doesn't really matter in a podcast.
Well, I think you look fabulous, and I think it's unfortunate that we're not on video with this, but...
You're such a flatterer!
You're here at BlueBay, and I've had the privilege of spending a good part of this week here in London with you and the team. What got you here - and how did you get into the investment space to begin with?
passion it takes you into financial markets. I'm extraordinarily privileged, frankly, to work for an institution like BlueBay where I get paid to do stuff that I'm really interested in and to debate the issues of the day both on the political side, on the economics, and of course express those views and analysis to deliver value to our clients. But I trained as an economist. I have a first degree and a Master's degree in Economics from the University of London. I spent ten years, actually, in public service that included working at Her Majesty's Treasury, so the British...
...Finance Ministry, and I spent time working in the International Finance Directorate there, advising British Ministers on G7, IMF, European issues, and also in terms of debt negotiations and debt restructuring. I was spending many long hours into the early hours of the morning in Paris at the French Treasury negotiating the restructuring of former Soviet Union debt with other G7 colleagues, including from Canada. At that time I was a middle-ranking official. There are several billion pounds worth of debt owed to the UK from the former Soviet Union, basically export credits. This is a huge responsibility with a delegation. And then as we went round the table sort of realized actually that Germany was owed about 40 billion, so I could largely leave it to the Germans to strike a good deal. The Germans are pretty good at striking... are pretty tough when it comes to their negotiations.
And then after leaving the Treasury, I spent some time... a short period of time at UBS Investment Bank, and then I led and developed the global sovereign ratings team at Fitch Ratings, so country risk in emerging markets. Something I've always very much enjoyed, going to places Ashgabat, which is the capital of Turkmenistan. As you can imagine, as a credit analyst, the first thing you'd want to know is how much debt do you owe? And the response we received from a senior official was, "I'm afraid I can't tell you that, because it's a state secret," and I thought we've flown a very long way and we're not getting very far if you won't even tell me how much debt that you have.
And then I was very much interested, having a lot of interaction with investment managers and investors. I knew BlueBay from its reputation in London and more broadly across Europe, and an opportunity arose to be Chief Investment Strategist. I thought this is fantastic, that they're willing to take a seasoned veteran - is maybe the polite way - on in this role, and they think that I can add value, and I'm still here almost six years later. So I think that means that I am adding some value.
It's interesting, having, again, been spending time with a lot of your colleagues here at BlueBay this week, when I talk to people here, I would say one of the characteristics that you just feel it in the environment is that passion for what people are doing here. What do you think it is about BlueBay that just seems to have brought so many passionate people together around their individual area of expertise into what they do?
There is a really strong and challenging culture, actually, at BlueBay, and it's about sharing insights, sharing expertise, having a diversity of perspectives across the firm and across the investment floor, and that actually makes it very exciting. Because the focus as active specialists, fixed income managers - we don't do anything else: that's what we do - our range is from active long only to long short, to hedge funds. So, it's all about delivering investment performance. It's all about delivering value to our clients.
But with that focus, within that focus, with the range of people that we have it's just a very exciting and dynamic place to be working. It genuinely is a pleasure, as well as privilege, where with the assets that we manage across emerging markets, across global fixed income and credit, that we have pretty challenging debates internally and using a range of insights from policy-makers and other networks that we draw upon to then deliver that performance, and you just get a real buzz and good feeling from it. Therefore that culture I think feeds through.
There's a lot of intellectual curiosity and willing to learn, and recognition that we don't always get things right - but that's the nature of the business that we're in - but then, okay, we move on from that. Let's learn and let's try and do it better next time and just minimize where we've made an error, or the world changed in a way that we didn't expect. It's just a lot of fun with a lot of fun people.
Yeah, I know. You feel it when you're here. It really is incredible. I think, as an investor myself, that if I was investing, that is what my expectation would be of, of the firm that I'm entrusting my money to, that you have that passionate group coming together, challenging each other and really striving for results, because that's ultimately at the end of the day what we need to produce as investment managers. If we talk about passion for politics and economics, we are taping this in London, England, on March 28th. For someone like you...
I know where this is going...
...there might be nothing more exciting than Brexit and everything that's going on there. For a Canadian audience, from an English perspective, what do we make of all this?
Well, let me take the opportunity maybe just to step back a little bit and say that what I do think Brexit, you know, populist governments within continental Europe, I do think the election of Donald Trump as US president, that it's part of I think an important theme and change of populism, less predictable policies. I think that means more interventionist governments and states in markets, as well as in broader economies on certain things like trade policy, as well.
I think Brexit has been very interesting in that respect, because I think it's important to see it in that context, and one of the things we've done at the firm, at BlueBay, is to invest more in developing our network of political and policy contacts, use a much broader range of tools to garner intelligence, not relying on, dare I say, the mainstream media.
Now, to your question - I know. I'm sort of tip-toeing around it a little bit in terms of Brexit. It's self-evident. We're really reaching a crunch point now. Parliament, quite extraordinary, really, has wrested control from the Executive... The British Parliamentary system is really an elected dictatorship. Once you have the election, then the Executive, with the majority in Parliament, really can do almost whatever it likes. There are very little constraints. As you know, there's no written constitution. We're now in this extraordinary situation where the government has even lost control over the agenda within Parliament, so, as we speak, they're looking at different options to Prime Minister Theresa May's deal that she negotiated with the European Union.
Ultimately, I do think that we're most likely to end up with a further extension. So I'm afraid to say that Brexit will continue beyond the current deadline, which is April 12, through the remainder of this year. But I also do think that markets right now are probably a little bit too complacent about the risk of a no-deal, which is a total risk but not insignificant, and I think it would have certainly a big impact for the UK economy for sterling assets, but I think it would have spillover effects, as well, both into Europe and potentially more widely, at least in the short term, and also the prospect of another General Election within the UK, as well.
So, it is extraordinarily interesting going down to the House of Commons when meeting MPs. I have to say that's one aspect where you do spend time with politicians, and you find actually when you've come out of the meeting that actually you're less informed and less clear about what's going to happen in the future than more informed and more confident about what is going to happen in the future.
But from our perspective where we do have sterling assets and sterling exposure in our portfolios, we've been looking at where we can get we think cheap insurance to preserve the capital of our clients, and also to see where there are opportunities to make money for our clients, as well.
From an investor perspective, what action do you think investors should be taking? Or should it be a case of kind of inaction, and just letting things play out? And how fearful should investors be about where this could go?
I do think that it's very dangerous, if you like, and certainly it'd be a very brave investor to trade the news flow around Brexit, given the level of uncertainty that we have and the different options that are open to the UK, because of course we have various factions within Parliament, we have the UK Government itself, which may or may not survive this process, and of course there's the European Union involved in this negotiating process, as well.
What I do think is that, at the moment, the market is pricing sort of a 5% to 10% risk of a no-deal Brexit. If there was a no-deal, then sterling would clearly fall pretty dramatically I think. I think it'd go to sub-$1.20 against the US dollar to parity against the euro. So one of the things that we have been doing, at least as investors, where we have some, for example, UK credit in our portfolios, we think that sort of 5% to 10% chance it's being priced is somewhat low, so we do think there's some cheap insurance by having an option to benefit from a fall in the value of sterling, even though it's not our base case that there is a no-deal outcome.
There are some opportunities actually in sterling credit I think for investors. There's been some re-pricing. There is some Brexit premium. So if there is a softer Brexit or a transition, a longer transition period or extension period - or even a no-Brexit, can't be wholly ruled out - then I think there is some value for investors there, as well. Then finally, there are UK government bonds, very much dominated by local, UK institutional investors. But nonetheless the UK has effectively got negative real interest rates for an economy that's running a pretty large trade deficit and does need to attract overseas savings to fund itself.
So, in response to your question, Dave, about the worst case outcome, then I do think that if there was a no-deal, there would be very severe impacts on the UK economy. Sterling would fall off very dramatically, and although UK government bonds would rally in the short term, I do think that you'd start to get some kind of risk premium coming into sterling assets and pushing gilt yields higher.
How much growth would it take out of the UK and European economy?
In the event of a no-deal exit, which would be actually on April 12th...
...and where there've still been relatively limited preparations, then the disruption to the integrated supply networks that've built up over the last 30, 40 years, I think would push the UK economy into recession. So the UK economy is currently growing at around about 1.5%, so not great, but not terrible, either.
So I think pretty quickly the UK would go into minus-1%, minus-2% growth within a fairly short period of time. The UK economy would adjust and adapt, but I think the recovery would be quite slow. And I think in that environment, as well, we'd have more political uncertainty. Even under a no-deal Brexit, the UK still has to negotiate trade arrangements with its...
T...nearest and largest trading neighbours. So the idea that a no-deal means no negotiation is, in my view, untrue. I think for the European economy, which is already relatively fragile - I mean, growth is less than 1% right now...
...so it would shave 0.2, 0.3 percentage points off that growth rate for countries like Ireland, clearly, which has got very historical reasons, huge amount of exposure to trade relations with the UK, then that would be more severe, but also countries like the Netherlands, as well. I think what it would also means is that you'd see a further lag down or further rally in global government bonds. One of the features we're seeing this year - I mean, maybe it's been one of the defining features I think of the first quarter of this year - has just been how we've seen this huge rally in government bonds because of the decline in government bond yields and expected interest rates. I do think that a no-deal Brexit would actually provide another lag lower in global yields because, although the UK economy is a relatively small economy, nonetheless I think it would be an unexpected shock at a time when, as we've discussed, Europe is looking quite fragile, and people are concerned about global growth and global trade.
And so that's kind of the worst case scenario in terms of the impact on the UK in particular, but Europe, as well, and obviously you focused on Ireland. What is the most likely outcome from your perspective?
I think the most likely outcome is that the UK Parliament will adopt a framework which would be one where there would be a closer relationship with the European Union including entering into a permanent customs union arrangement, and a closer tracking, if you like, of EU Single Market rules. Not least because not only the financial services sector, but the manufacturing sector, much of which is from Japan and elsewhere, has really been integrated into the European supply chain and to serve the broader European market. So if Parliament, over the next few days, is able to coalesce around a sort of softer Brexit outcome, then I do think that the European Union will then agree to an extended transition in order to negotiate the details of that. That being said, one could not discount even in that scenario that the current government would face a vote of no confidence prompted by those in opposition to a softer Brexit, and so there could be another General Election which would be another source of uncertainty. But if we take that and extended further extension to the negotiation process, which means the UK remaining in the European Union for the foreseeable future, then I think there's some upside to sterling. I think there will be a relief rally of the pound, and I do think that gilt yields, UK government bond yields, would move somewhere higher, and we'd see a bit of tightening in terms of credit spreads on things like UK banks, which would suffer to some degree as a result of certainly a worst case scenario of a no-deal Brexit.
But it sounds like most likely we'll be back in about three months doing another podcast talking about where we are at that point, and where we're going, because this is really far from settled.
Absolutely. That was actually much more concise and pithy than my response. You're actually right. This is going to be, I think, the most likely outcome, is there's going to be an ongoing process, and amazing though it may sound to many of those listening, this is about negotiating the withdrawal of the UK from the European Union. The UK and the EU haven't really got into a discussion yet about what the new arrangement will actually be. So the best that one can hope for is that there's, if you like, an orderly end to the beginning of Brexit. It's not yet the end of the Brexit process.
That's great. We'll book another discussion for a couple of months out.
I look forward to that.
And I'd also like to dig in, because one of the other things you said that was really interesting is a dig in on this what's happening with populism...
...in the UK, in Europe, and obviously in the United States, and the longer term impact of that and the disruption that that caused. I think that'd be a fascinating discussion.
I'd love to, yeah.
David, thanks again for joining us today.
Thank you. Thank you very much, David.