Portfolio managers: Three tips for proactive Brexit preparation

January 16, 2019

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by Alistair Dick Corporate financial restructuring

Email +44 (0)7921 872176

“How do I prepare my portfolio for Brexit?” That's an increasingly common question I'm hearing from portfolio managers working for private equity funds, banks, insurance companies and credit funds. While there might not be a ‘silver bullet’, I wanted to share three ideas I’ve been discussing with my clients to help them prepare for the road ahead.

Before we get into the actions to take, it’s worth first having a look at what the data is telling us. In comparison to staying in the EU, the UK Government’s EU Exit[1] analysis suggests that Brexit will result in a reduction to GDP under all scenarios over a 15-year period, ranging from -2.5% in the Modelled White Paper to -9.3% in a ‘no deal’ scenario. Should this lead to a period of recession, we would typically expect to see the rate of business closures increase. For instance, official figures[2] show that the UK economy shrunk by more than 6% between the first quarter of 2008 and the second quarter of 2009, and took five years to get back to pre-recession levels. In the three years before that recession (2005-07), business closures averaged 220,000 a year, compared with 250,000 a year in the five  three years during and after it (2008-10)[3].

Whichever end of the GDP scale we fall on, many businesses may face challenges, and those companies with the least financial flexibility will face greatest risks. To protect your investments, pre-emptive planning is the key, starting with these three steps:

  1. Carry out a portfolio review

With political negotiations continuing, portfolio managers and business leaders might be unsure about what action to take. We’re advising our clients to start by reviewing their portfolios for signs of stress.

The key is to be specific, taking a diagnostic approach to identifying risks, so that they can be isolated and managed efficiently. We typically support our clients by getting the business leaders to work with relevant specialists to review company information against risk categories (e.g. customer and supply chain, people and immigration). It’s a simple framework that highlights if an entire portfolio faces a common risk, or if a specific business is exposed to multiple risks.

For example, some portfolios are exposed because they’re weighted towards one industry. If we take construction and manufacturing firms, they’re heavily reliant on goods coming through the EU supply chain. They may in future face issues sourcing materials, or keeping the flow open for things that can’t be stockpiled (e.g. concrete). If your portfolio is weighted to one industry, a diagnostic approach will highlight where you can take best practice from one area and apply it across all investments.

In other portfolios, the risk might actually centre on one or a small number of specific businesses, each exposed on multiple fronts. In these situations, it’s best to focus remedial work on the ‘at risk’ businesses, especially useful to help you make best use of any thinly stretched resources.

In short, a diagnostic approach will help you focus your efforts more efficiently.

  1. Make your ‘no regrets’ decisions

Brexit will impact businesses in a variety of ways. Changes in immigration and citizenship might lead to staff challenges - perhaps a shrinking workforce, or issues with the ability of key staff to work in the UK. Or, as discussed above, supply chain issues could mean it becomes harder to source materials or ship products.

While ‘no deal’ remains a real possibility we have recommended contingency actions you can take now. At the same time we could still face disruption if a deal is agreed, caused by the short timeframes we face. Any deal now would only give certainty about the UK's relationship with the EU during the transition period, but we would still have little detail about what the trading relationship after would look like after the transition period ends. To address these impacts, we’ve defined eight no regret’ decisions  that we think businesses should consider to lay the groundwork for future trading beyond Brexit. It’s important to consider these now.

So, deal or no deal, it’s vital not to wait for certainty before you take the ‘no regrets’ decisions.

  1. Revisit your financing structures

Whether you’re an investor, lender or a business leader, we recommend reviewing the ‘pinch points’ in your financing structures that could cause issues over the next few months.

As an example, we anticipate that Brexit disruption could lead to a significant strain on working capital. This means you’ll need to consider how your businesses will finance this – do they have adequate facilities in place, or do they need to increase their overdrafts or seek other short-term funding.

Perhaps more importantly, any pressure on working capital is likely to manifest itself through higher net debt– and many leveraged companies will have covenant tests coming up on 31st March, coinciding with the ‘leave’ date. While this may be a temporary spike, it’s a problem if net debt is peaking when covenant tests are happening. So consider whether covenant relief is an option, to prevent a short-term issue creating additional cost and risk for your company.

Time to act

The critical message is that it’s time for portfolio managers and businesses to be working together to prepare for Brexit. Success will come from a strong partnership between investors and the businesses they invest in, identifying the risks and taking action together. The sooner you can identify the issues and the risks, the better prepared you will be to address them, and the more robust your portfolio will be.

Stay up-to-date with the latest Brexit negotiations, review the technical notices and guidances being released by the UK Government and the EU, and ensure that your contingency plan is both prioritised and comprehensive, and that the right action is being taken at the right time. 

[1] UK Government, EU Exit Long term economic analysis, November 2018

[2] ONS, The 2008 recession 10 years on, August 2018

[3] ONS, Business demography, UK: 2017

by Alistair Dick Corporate financial restructuring

Email +44 (0)7921 872176