Canada Life Investments’ Arnaud banks on Q4 Brexit deal with sterling overweight

Arnaud, who co-manages the £241m LF Canlife Global Bond fund alongside Kshitij Sinha, said the move is a “tactical short-term call” as the team attempts to “pre-empt positive market movement” as he anticipates a deal will be reached “at some point in Q4”.

Brexit negotiations have been slow to progress since Article 50 was signed in March last year, held up by disagreements over the future of the Irish border and opposition to Prime Minister Theresa May’s Chequers plan from EU negotiators and across parliament, including a significant proportion of her own MPs.

While these concerns exist, hope of a deal has been offered by both sides of the negotiations over the course of October. EU chief negotiator Michel Barnier announced a Brexit deal is 90% done, followed by May’s speech to parliament a few days later in which she said 95% of the deal is done.

Arnaud said: “Both sides are beginning to make similar, positive claims about the likelihood of a deal. For us, it is clear Europe and May are now working on the same page.

“At some point in Q4 there is going to be a tangible, positive development on Brexit, coming from the EU and Theresa May, on an agreement.

“We are trying to pre-empt positive market movements. The announcement of a deal will see sterling rally, and we will benefit from that rally before likely reducing sterling to a more neutral position. We will then reassess our stance for the transition period, beginning on 29 March.”

So far in Q4, the fund has built up the overweight sterling position of 18% versus 6% for the typical benchmark, financed through accumulated inflows, according to Canada Life Investments.

The fund’s sterling exposure includes 5% in gilts, with the balance in corporates including financials such as Prudential, Barclays and Zurich.

Arnaud added the fund will avoid the risk of parliament voting down May’s final deal by reducing the position following the announcement, adding a change in leadership in the UK would force a complete reversal of the position.

He explained: “Of course, if the hard Brexiteers get together for a motion to oust Theresa May, we are back to square one. We would have to reverse the position.

“We are in pure politics territory now.”

Sticking with financials

Elsewhere, Arnaud reaffirmed the fund’s bias towards financials, where the management team built an overweight position at the start of September acknowledging the fund is yet to see the benefits of the decision.

Writing in Investment Week  earlier this year, Arnaud said that financials, particularly with regard to banking and insurance issuers, offer high breakevens and the best risk/reward buffer against rising interest rates.

He explained: “The rationale behind that trade at the start of the year was the banking sector is in a much better shape than it was three or four years ago, owing to [post-crisis] regulations forcing banks to be better capitalised.  

“However, interest rates, in Europe at least, have remained low so bank profitability has failed to go up.

“[In addition] bank and insurance company bonds have been used as a proxy for government bonds, in a
risk-off environment for government bond investors.

“There has been contagion from government bonds to the banking sector, as investors use them as a leverage play on domestic economies.”

Despite the pressures faced by financials in 2018, Arnaud is confident they will fare better in 2019, with the manager backing eurozone rate rises amid a more stable political backdrop.

He added he does not expect existing political risks like Italian fiscal expansion to hurt European insurers with “strong names” held in the fund like AXA or Zurich, which are “well capitalised and not exposed to a market sell-off”.

He said: “We are positioned for higher rates so we are long the banking sector.

“Next year the sovereign pressure should be lighter. In Europe, we are approaching a less intense year for general elections, thereby reducing political risk.

“In this environment, we expect Europe will follow the US and interest rates will go up.”

The LF Canlife Global Bond fund is down 2% over one year, but up 23.8% over three years and 24.1% over five years to 23 October, according to FE.

Meanwhile, the IA Global Bonds sector has lost 1.4%, and gained 19.3% and 19.9% over one, three and five years respectively.

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