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Liquid alts and private debt most likely to benefit from Brexit

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Liquid alternatives and private debt are the asset classes likely to benefit most from Brexit, while institutions in countries where a higher allocation to equities and bonds is the norm are likely to be most affected.

These are the key conclusions of a new research paper from bfinance: ‘Working through the Implications of Brexit’.
 
The report explores the implications of Brexit, tracing the shock through the economic drivers and into the main asset classes, providing institutional investors with a framework to help understand and manage the aftermath of the UK’s historic decision to leave the EU.
 
The starting point is research into the ways in which shocks might impact GDP and inflation and, in turn, influence cash flows and discount rates. This linkage between the economy and drivers of financial market performance is then used to explore the impact of Brexit on the range of different asset classes.
 
Equities and fixed income tend to be inversely related to GDP and inflation drivers respectively, while private asset classes are distinguished into those that are more equity or growth focused, such as equity real estate, infrastructure and private equity itself, and more debt focused, including corporate, real estate and infrastructure debt. These private asset classes would be expected to provide some insulation to due to their intrinsic characteristics, which mean they are less likely directly related to GDP and inflation than the more liquid equity and bond classes.
 
The report suggests that liquid alternatives and private debt will benefit the most from Brexit. Liquid alternatives will profit from the increased dispersion associated with the greater uncertainty at both stock and sector level. They also have a low sensitivity to changes in GDP due to the diversity of strategies and return drivers and have a low sensitivity to inflation given LIBOR+ return targets and the fact that relative value (RV) strategies typically hedge interest rates.
 
Private debt, which includes corporate, real estate and infrastructure debt, and niche strategies such as life settlements and trade credits, is set benefit from the relatively high yield, the reduced competition from banks and the resilience to a downturn in values and cashflows. This is particularly the case for more senior debt and less so for higher yield of mezzanine debt that has less of a cushion to protect loans from value decline. Private debt strategies are also less directly related to GDP and inflation than more liquid and equity and bond asset classes.
 
The relevance of the report’s analysis will vary according to the specific situation of individual asset owners, based on their investment objectives, current portfolio and view on the various macro- economic and financial markets outlook.
 
Toby Goodworth, head of risk and diversifying strategies at bfinance, says: “The analysis provided in this paper is high level and illustrative of the relationship between economic shocks and asset class performance and preferences. It is in this context that private debt and liquid alternatives stand out as the best performing asset classes following the referendum vote, and one we expect to have higher relevance for asset owners in the coming months.”
 
Returns across the various asset classes demonstrate that financial markets have been generally resilient past a short initial period of sell-off. Although there remain significant concerns over the consequences for economic activity and financial markets, it feels as if the markets shrugged off Brexit and decided not to respond to the potential impact until the publication of the first economic data post-Brexit and until the exit conditions negotiated with the EU become clearer, the report says.

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