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Where do Hedge Funds Stand on Brexit and UK Assets?

Risk aversion was rapidly overcome as Tech and Energy stocks rallied. HF were strongly up, driven by the performance of Special Situations, CTAs and Macro funds. Most impacted last week, they fully recovered.

Amid intensifying negotiations on Brexit, we assessed hedge funds’ views on UK assets. The sixth round of negotiation ended with limited progress. The EU and the UK have yet to agree on the exit terms before negotiating the future trade relationship. The multiple fractures in the UK (across political forces, business interests, regional powers) and the European hard-line suggest that uncertainty will last well into next year.

It became apparent that Brexit uncertainty sidelined the UK from the global economic re-acceleration. Investment is cooling as businesses hold off their projects. Consumption is rapidly weakening in sync with wage growth and employment. The surge in inflation – largely FX driven – forced BoE to raise rates at an inopportune timing.

For a time, dynamics were clear. UK yields dropped and the GBP plunge boosted FTSE, which sources 3/4 of its revenues abroad. Since then, weaker economic prospects got priced in and GBP became floored by rates prospects. Like GBP, yields entered a range trading, mirroring skepticism that BOE will be able to hike much more. FTSE is also capped by falling domestic revenues prospects and weaker FX support, but supported by healthier valuations and growth abroad (at least for stocks exposed to non-EU global markets). UK assets stand at crossroads with less obvious near-term short or long catalysts.

Hedge funds’ positions are heterogeneous. CTAs neutralized most of their UK exposures. They are marginally short GBP, modestly long Equities and Bonds. By contrast, Macro funds are more decisively short GBP and Bonds, but moderately long Equity. They expect higher rates, a weaker economy, and some FX-upside for FTSE. While uncertainty is palpable among L/S Equity managers, they kept their gross and net UK exposures stable. However, they favor longs in large cap and grew their shorts on segments vulnerable to domestic weakness. These include consumer, retail, reits, staples, leisure, or media stocks.

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