It was in 2014 that Scotland held a referendum on whether or not to become an independent nation. There the polls also pointed to a very close result but there was a steady increase in the number of voters who would vote “yes” to Scotland leaving the United Kingdom. In fact, just prior to the actual vote in September 2014, a YouGov poll showed the “leaves” would win. This was not the case; after all the votes were counted a massive 55% of Scots voted to remain. It seemed as if, when the cross had to go on to the ballot paper, voters backed down. Surely with the UK’s referendum on whether or not to remain as part of the European Union, with opinion polls firmly pointing to a Remain vote, and the likelihood of undecided voters electing for the status quo, there wouldn’t have been any possibility of the UK divorcing itself from the European Union?
At 10pm when the media were allowed to publish details of exit polls it seemed that the UK would remain as part of the European Union, indeed Nigel Farage, leader of the UK Independence Party almost, but not quite, conceded defeat. Roll forward a few hours, and traders and portfolio managers in the country woke up at their usual ungodly hour, assuming Nigel’s political career would surely be in tatters. It was not to be. Remarkably, it was Prime Minster David Cameron who would be offering his resignation and dawn broke to a United Kingdom that may not be so united in the future, and was certainly going to follow Article 50 of the Lisbon Treaty.
Article 50 states: “Any member state may decide to withdraw from the Union in accordance with its own constitutional requirements.”
It specifies that a leaver should notify the European Council of its intention, negotiate a deal on its withdrawal and establish legal grounds for a future relationship with the EU. On the European side, the agreement needs a qualified majority of member states and consent of the European Parliament.
The only real quantifiable detail in the article is a provision that gives negotiators two years from the date of Article 50 notification to conclude new arrangements. Failure to do so results in the exiting state falling out of the EU with no new provisions in place, unless every one of the remaining EU states agrees to extend the negotiations.
The United Kingdom will now be invoking Article 50, although the timing of this is, as yet, unclear. The first, and maybe now, not the last country within the Union that has shown a red card to a centralised European state.
Opinion and comments on social media changed dramatically. Prior to the vote, there was an equal amount of posturing, those who thought that the UK would be better off within Europe were equally matched with those who though the future would be better once extricated from the Union. The flow of comments on 24th June were littered with pictures of Boris Johnston on a zip-wire looking like a hapless buffoon and many Remain supporters holding their heads in their hands, accusing those who voted to leave of causing irreparable damage to the country. Interestingly enough, those who were vociferous in stating that the UK would be better with total autonomy, were strangely quiet. Maybe it is a case of “what have we done…?”. It is now too late to ask that question, and even though a petition has been raised to conduct a second referendum, the fact is that the UK will be going it alone within the two-year timeframe, according to Article 50 that is.
The impact of the vote has been substantial. Asian and Australasian equity markets slumped (the Nikkei plummeted 8.5%) and, as expected, the effect on the Pound was even more profound. At 11pm on the 23rd the Pound was trading at 1.5080 against the US Dollar, six hours later it touched 1.3240, its lowest level since 1985. The UK equity market also followed suit and the most watched 250, fell 10% and then recovered to close the day a shade over 7% lower.
The UK exiting the European Union will be messy, it will resemble a difficult divorce with a large degree of uncertainty and volatility within investment markets and beyond. But it will be manageable. Prior to the vote many politicians advised that there would be severe hardship in the years to come for a UK with its umbilical cord severed:
U.S. President Barack Obama said on 21st April 2016: “Britain would go to the back of the queue” and would not be able to strike a trade deal with America “any time soon” if it leaves the European Union.” And on the 24th June 2016: “Britain’s vote will not derail our special relationship”, “We respect their decision”.
It is worth remembering that most equity markets are higher now than they were just two weeks ago; the FTSE 250 closed at a 16,032 on the 16th June, as for the Pound, it rebounded substantially from its low point. Undoubtedly there will be volatility to come as details emerge about the mechanics of Brexit. Individual stocks have also been sold heavily, especially the banks. Barclays Bank fell 17% on Friday, albeit in excess of 10% off its lows, Lloyds Banking Group and Royal Bank of Scotland closed 21% and 18% lower respectively. The banks will now have to jealously guard their capital - and it is here that the Alternative Finance market will flourish. The availability of bank capital to provide loans to SMEs will reduce and alternative sources of finance will likely increase as a percentage weighting in the total lending statistics.
Implications for the alternative finance space
The Alternative Finance space, although out of favour during the past 3 months (the catalyst being the debacle at Lending Club in the US), is I would argue extremely well placed to provide investors with a haven of (relative) calm. There is no doubt that borrowers who have a significant proportion of their revenue derived from the European Union may have to adjust their business model and this is something to which our credit specialists at Amberton Asset Management are attuned.
Amberton, as managers of GLI Alternative Finance Plc, are resolute in their selection of low risk SME loans. While the prospectus of the Fund allows for leverage, none is currently employed. There are loan impairments (accounted for within the monthly Net Asset Value calculation) however these are entirely within expectations. Currently the loan impairment rate of approximately 2%, has led to a reduction in the NAV of just 0.80%. One of the reasons behind this low impact on the NAV is the high exposure within the Fund to secured debt.
GLI Alternative Finance Plc Secured vs. Unsecured Loans
Data source: Amberton Asset Management 31st May 2016
Financing SME loans is a very different investment proposal compared to consumer finance which has much less transparency, leading to less credit analysis being possible. Company accounts are checked for cash flow, balance sheet strength and stability in financial performance. After full due diligence is carried out, selective investments are made for the Fund with gross yields typically 8% to 12%. The share price of many Alternative Finance investment trusts fell on Friday, GLI Alternative Finance Plc was no exception. With the share price closing at a discount of 11%, a level where the dividend yield has hit 7.4%, this represents an attractive level. The NAV total return of the Fund has been impressive and this is expected to continue:
Data source: Amberton Asset Management 31st May 2016
Currency exposure within the fund is hedged back to base currency, GBP. With the Pound weakening substantially, holding non base currency unhedged would have given rise to significant increases in value and the NAV would have risen by approximately 2.5%.
The message is clear, while there is short-term uncertainty, the long-term future of both the United Kingdom and the Alternative Finance sector is strong and there are opportunities to be seized.
Graham Glass MCSI
Amberton Asset Management Limited