Brexit Webinar: Implication for Eurozone investors

Brexit implication for

Eurozone investors

© 2016 Willis Towers Watson. All rights reserved. Proprietary and Confidential. For Willis Towers Watson and Willis Towers Watson client use only.

UK leaving the European Union

2

Three key messages

EFFECTS OF BREXIT

• This is a local (UK) shock rather than a global shock

• There are two main channels through which the European economy is

affected:

• Policy uncertainty

• Terms of trade

• The big risk is the possibility of a “referendum” in a major Eurozone

economy


3© 2016 Willis Towers Watson. All rights reserved. Proprietary and Confidential. For Willis Towers Watson and Willis Towers Watson client use only.

Market reactions to Brexit were relatively rationalMarket reactions were broadly consistent with our expectations of Brexit implications

Sterling Bond yields (10 year benchmark)

Corporate credit spreads UK large-cap equities (FTSE 100)

Sources: Factset, Willis Towers Watson

UK mid cap and EZ equities

% pa Index, 16/3/2016 = 100

Option Adjusted Spread, bps

World equities

1.1

1.2

1.3

1.4

1.5

Jan 16 Mar 16 May 16 Jul 16

GBP vs USD

GBP vs EUR

-0.5

-0.2

0.1

0.4

0.7

1

1.3

1.6

1.9

2.2

2.5


US UK Ger80

85

90

95

100

105

110

Mar 16 Apr 16 May 16 Jun 16 Jul 16 Aug 16

Germany DAX (TR)

Italy FTSE MIB

FTSE 250

80

100

120

140

160

180

200

220

240


US IG

UK IG

Euro IG

90

95

100

105

110

115


Index, 16/3/2016 = 100 Index, 16/3/2016 = 100

90

92

94

96

98

100

102

104

106

108

110


Global EM

EFFECTS OF BREXIT

The post-Brexit world

4

Scenarios link political, economic and investment outcomes

Political/

diplomatic

outcomes

Economic

pathways

Capital

market

impact

• UK political leadership

• Eurozone political contagion

• Timing of Article 50 notification

• Speed and outcome of trade

negotiations between:

• UK & European Union

• UK & Non-EU countries

• Monetary & fiscal policy

• Wider financial conditions

• Investment

• Employment

• Prices and real incomes

Un

ce

rtain

ty c

ha

nn

el

Tra

de

ch

an

ne

l • Terms of trade with EU and rest of

world

• Long-term impact on foreign direct

investment

• Immigration as a source of labour

• Impact on productivity growth

Drives shifts in risk

premia and feedback

loop of tighter/looser

financial conditions into

the economy

Important for long-term

cashflow generation

prospects for European

assets and terminal cash

rates

Use WTWs processes and models to establish these linksAdjust as events unfold


EFFECTS OF BREXIT

The outlook for the European economy

5

Four key scenarios


EFFECTS OF BREXIT

Source: WillisTowersWatson

Scenario Economic policy, investment and consumption Trade deals and timing

1. Good Brexit/

Renegotiation

• Near-term uncertainty reduces UK investment

• Central bank easing supports confidence and investment

• Longer-term impact is minimal

• No Brexit (continued EU membership)

• Or trade under European Free Trade Association type

arrangement (Switzerland

2. Central • UK business investment and hiring slower

• Monetary stimulus and fiscal “easing” helps

• Anti-establishment sentiment moderately increases

• EU Customs Union type deal agreed after 5 years

3. Bad Brexit • Lower European investment, hiring and incomes

• Fiscal and monetary stimuli ineffectual

• Ineffective functioning of EZ institutions; increased support for

populist parties

• Trade with EU under WTO terms

• Gradual bilateral agreements state by state

4. Eurozone

break-up

• Key EZ member elects to leave

• Very large investment, trade and consumption shocks

• Policy provides liquidity but cannot offset major negative demand

shock

• Trade with EU under WTO terms

• Gradual bilateral agreements state by state

The direct and indirect effects of Brexit on the UK, Eurozone & US

6

Central outlook and scenarios


EFFECTS OF BREXIT

Source: WillisTowersWatson

The spill-over effects of Brexit on GDP

-12.0%

-10.0%

-8.0%

-6.0%

-4.0%

-2.0%

0.0%

GoodBrexit

Central Bad brexit EZBreakup

GoodBrexit


GoodBrexit


UK Eurozone US

% GDP

Peak impact on GDP levels under our Brexit scenarios, relative to our pre-referendum forecasts

Recommendations for investors

7

Three key messages


EFFECTS OF BREXIT

“Business as usual”: Management action is typically required when any

market price moves a lot

“Adjusting to the new world”: Investors should consider if their current

long-term journey plans are consistent with this “new world” of low interest

rates and expected asset returns

“Dynamic views”: With the market response to Brexit reasonably rational,

we currently have few Brexit-linked dynamic asset allocation

recommendations

8

How we see the world


Our mental model of the world

BACKGROUND

Debt overhang

(50%)

• Moderate growth

• Low returns due to low rates and

low/average risk premia

• Policy rates and bond yields rise

very slowly

• Strong production-

led growth

• Good equity returns

• Bond yields rise

more than

discounted

Inflation/

bond yields

Downside

(40%)

Upside

(10%)

• Weak growth

• Significant equity

drawdowns

• Deflation risks

• Low ratesGrowth/

equity returns

Bubble size

indicates likelihood

How would we design a portfolio today?

A Better World Investment and / or innovation increase productivity

Downside Risks Downturn with limited ability of central banks to offset

Debt Overhang Global economy remains at or near its borrowing limits

WTW view on likelihood

50%

10%

40%

Good returns from mainstream markets have helped pension plans in recent years.

The outlook from here is economic instability, limiting growth

9

40%

Appropriate hedging To reduce the high exposure to rates and inflation

Smarter implementation To find more cost effective ways to invest

More diversity To reduce substantial reliance on macro sensitive assets

This outlook calls for …

Downside risk management Especially important for cash-flow negative schemes


Asset drawdowns always matter

10

Becoming increasingly important as funds go cash-flow negative

40%

50%

60%

70%

80%

90%

100%

110%

2015 2017 2019 2021 2023 2025 2027 2029 2031 2033

Median FL Shock FL

7% downward

shock….

….results in the

Journey Plan

being extended

by 10yrs

An example for a plan with net negative cash flow of around 5%pa

A downward shock, combined with the need to pay out assets, materially impairs the

overall plan objective


Scenario analysis in portfolio construction

© 2016 Willis Towers Watson. All rights reserved. Proprietary and Confidential. For Willis Towers Watson and Willis Towers Watson client use only. 11

Building more robust portfolios

Appropriate hedging

60%

65%

70%

75%

80%

85%

90%

95%

100%

2016 2017 2018 2019 2020 2021

Fu

nd

ing

le

ve

l

60%

65%

70%

75%

80%

85%

90%

95%

100%

2016 2017 2018 2019 2020 2021

Fu

nd

ing

le

ve

l

More diversity

Downside risk management

Central global economic scenario

Downside global economic scenario

Eurozone fragmentation scenario

Traditional 50% equity / 50% bond portfolio Diversified portfolio with liability hedging

Possible options for the UK terms of trade

12

Where will the line be drawn?


European Union Customs Union

European Free Trade Association

European Economic Area

European Union

Euro area

Standard WTO terms

?

1. Mission &

Beliefs

2. Risk

Management

Plan

3. Portfolio

construction4. Implementation

5. Monitoring

Governance

Framework

The key advantage of fiduciary management

13

Real-time portfolio management generates the highest value

Portfolio

Management

Strategic

Positioning

Continuous

Improvement


For further information relating to implications for

investment please email Joseph O’Dea.


Please visit our website for more Willis Towers Watson

insights on EU Referendum.

mailto:Joseph.O'[email protected]

https://www.willistowerswatson.com/en/insights/2016/06/the-eu-referendum