Brexit: What Just Happened? | Chief Investment Officer

CIO216-Article-Image-Nick-Reeves_ALT That noise you just heard? It was 700-odd European Union (EU) politicians simultaneously choking on their croissants.

The UK public has voted to leave the union.

Things are moving fast today. Already, Prime Minister David Cameron has given himself four months’ notice, pledging to step down in October as the country needs “new leadership.”

Markets opened early in London and are still whipsawing as news and views emerge. The pound has reportedly taken such a hammering that France is now a bigger economy than the UK due to the fluctuating exchange rate.

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We’ve been asking “what does Brexit mean?” for weeks, and very few have been able to bring any kind of certainty. For all the noise you’ll hear today, there will be very little indication of a true direction for either the UK or Europe for some time.

“It is now incumbent on everyone in the financial sector to work to try to mitigate the risk to our beneficiaries created by politics.”On announcing the referendum, Cameron vowed to invoke Article 50 of the Lisbon Treaty in the event of a ‘leave’ vote, which would begin the exit process. It’s scheduled to take two years to negotiate, but some have warned it could take much longer. The UK needs to get its negotiating team in place first, which will involve the ruling Conservative party trying to patch up the rift it created between pro- and anti-EU campaigners in the past few months.

On the European side, the EU’s openness to negotiation will depend upon which way of thinking wins out. On the one hand, the UK’s financial sector is crucial to Europe, and European politicians will likely be unwilling to put up barriers to doing business with London.

On the other hand, politicians will be fearful of a ‘domino effect’ throughout the rest of the union, and so may be reticent to make it easy for Britain to leave. Even before the polling stations opened, reports emerged in the pro-Brexit areas of the British press of demands in Italy, the Netherlands, France, and Denmark for similar public referenda on EU membership by predominantly right-wing parties. Ironically, the anti-Europe camp was citing European examples of why a united Europe was a bad idea. A poll by the Pew Research Center earlier this month found Euroskepticism to be growing throughout the EU’s population.

My inbox is already filling up with comments from asset managers, trade bodies, and other service providers. The overwhelming rhetoric is one of uncertainty, but with the expectation of immediate negative impacts across asset classes.

Pension funds, sovereign wealth funds, endowments, and foundations now need to prove they are long-term investors.

As Saker Nusseibeh, CEO of Hermes Investment Management, the BT Pension Scheme’s in-house asset manager, put it succinctly in a comment this morning: “Throughout, our main purpose remains to help our beneficiaries retire better… It is now incumbent on everyone in the financial sector to work to try to mitigate the risk to our beneficiaries created by politics.”

I need to sit down and drink a big cup of tea.

· Recommended reading: Buzzfeed’s “16 Pictures That Accurately Predict Life in Post-Brexit Britain.”

The world’s leading asset owners have already built large organizations and amassed trillions of dollars. But to become “truly great,” these institutions will need to develop new and better capabilities, according to McKinsey & Company.

In a survey of some of the world’s largest pensions and sovereign wealth funds, the consultant identified seven areas in need of improvement: culture, risk management, talent development, reputation, research, investment decision-making, and advocacy.

The top priority, cited by 89% of institutions, was to develop a high-performing culture that encourages collaboration.

“Organizations have grown up in silos around their asset classes—each with its own portfolio, investment policy, operating processes, and so on,” the report stated. “To successfully capture the next wave of investment opportunities that fall between asset classes, investors will have to build some bridges.”

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McKinsey’s advice? Identify both the current culture and the target culture, and from there determine the best path to get from one to the other. More specifically, the consultant added that funds can incentivize change through compensation and adapt tactical approaches to enable desired behaviors, such as a creating a pool of capital that requires cross-asset class collaboration.

Another high priority, listed by 69% of respondents, is “fixing” risk management to assess and manage risks that are evolving, especially as institutions grow their exposure to illiquid assets.

“Some institutions might use an absolute-risk perspective (complemented with some limited relative-risk measures),” the consultant suggested. “Some may consider looking to credit-risk assessments such as those used by banks to assess to the probability of capital loss for key investments.”

Almost equally important to surveyed asset owners was attracting and retaining investing talent. Here, McKinsey said institutions should leverage their unique value proposition: A chance to participate in some of the biggest deals in the world, freedom from the burden of raising capital, and the potential for young talent to take on more responsibility earlier in a career.

Good branding will also help funds stay competitive, both in talent and investments, the consultant added. Investment practices can be further bolstered by stronger internal research—on both portfolio construction and more thematic topics.

To “de-bias” the investment decision-making process—a priority for 59% of institutions—McKinsey said institutions should actively work to remove bias by strengthening and formalizing due diligence processes at every stage of an investment, including a post-mortem review of how decisions were managed when investments turn out poorly.

“Good (and bad) investment outcomes are mostly attributable not to the analysis that precedes an investment, but to the quality of the process and its adherence to standards of sound and objective decision-making,” the report stated.

Finally, McKinsey highlighted the need for advocacy—using asset size as influence to drive alignment of interests with other stakeholders such as the government.

“Building these capabilities will incur costs, of course,” the report concluded. “We strongly believe that the investments now required to reach greatness will pay for themselves.”

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