In a follow up to the recent 7IM roadshow, Chris Darbyshire highlights why in an alternative world, 7IM is increasingly looking at alternative investments.
Professional analysts, bookmakers and pollsters failed to predict the outcomes of two key votes in 2016. Contrary to most expectations, we are now hurtling down the road to Brexit and Donald J. Trump is ensconced in the White House. There is, however, a second link between these two votes: similarities in the electoral bases that voted these forces through.
With Brexit, it wasn’t the Tory votes to leave that surprised. It was the Labour voters in the Midlands and the North – an electorate neither unemployed, nor necessarily poor. They voted in their droves to "take back control".
In the US, meanwhile, it was the industrial heartland again – an electorate who had previously voted for successive Democrats – that opted for a sea-change in a political system they believe has failed them.
One explanation can be globalisation. While Occupy Wall Street has faded from the news, many feel unable to challenge the power of companies and supranational organisations, such as the EU, to the benefit of their local community.
But why now? Fears that free trade and immigration are taking away native-born jobs are not new. Trump’s "America First" rhetoric has considerable history. In 1860, Abraham Lincoln – the first Republican president – was voted into power on the back of protectionist policy, using the slogan "Protection to American Industries". In 1904, Teddy Roosevelt used the same slogan again, stating that "Protection, which guards and develops our industries, is a cardinal policy of the Republican Party". So globalisation on its own does not pass the ‘why now?’ test.
In the US, however, voter discontent has been exacerbated by the view that the Washington establishment has failed them. The rejection of the Washington elite in the US elections goes beyond Trump. He was only one of three maverick candidates contesting the 2016 presidential campaign: in fact, Hillary Clinton was the only established campaigner of the final four to be in contention.
Bernie Sanders is certainly not a conventional democrat – he is, in fact, the longest serving independent in U.S. congressional history and only positioned himself as a Democrat in 2015 in order to secure the party’s presidential nomination. He distanced himself from the party after failing to secure that nomination.
Ted Cruz, meanwhile, during his campaign pledged, once in office, to abolish the Inland Revenue Service, Department of Education, Department of Energy, Department of Commerce, and the Department of Housing and Urban Development! He is also linked heavily to the Federal Government shutdown in 2013.
The EU, meanwhile, failed to demonstrate to Leave voters the usefulness of its role in their lives – they only saw the downsides of freedom of movement and Brussels’ bureaucracy.But, above all, we believe that the real trigger for both Trump and Brexit has been a revolution in electioneering.
But, above all, we believe that the real trigger for both Trump and Brexit has been a revolution in electioneering and, specifically, in the use of the internet and social media. The increased sophistication of data analysis has enabled electioneers to use information gathered through the internet to segment the population and deliver a barrage of select, targeted messages that reinforce fears and deflect inconvenient facts.
The technology enabling such advances arrived relatively recently. Over the past decade, usage of the internet has been evolving towards a more personal, customised experience. In 2009 Google introduced a personalised search technology for all its users. Facebook introduced sophisticated customising technology to its newsfeed in 2011. Both use data which is personal to individual users to customise their websites. The results from your Google search or the top stories on your news feed are now different to everyone else’s, even though you might be using the same search term. Ostensibly, this helps you to sift through the raft of information on the internet and efficiently retrieve the results most relevant to you. However, usage of customer profiling goes far beyond this.
When using Facebook, for example, clicking ‘Like’ on 75 posts can (according to research by the University of Cambridge) determine your race with 95% accuracy, your sexual orientation with 88% accuracy and your political leanings with 85% accuracy. With 150 ‘Likes’, users of Facebook data state they will know you better than your spouse, while 300 ‘Likes’ can help them predict your reaction to an event better than you can.
The personalisation of news also means however that only like-minded views are increasingly likely to be served up to you. This means you are ever more prone to be living in a bubble of views that reinforces your personal biases and suppresses information that may cause you to challenge (and reject) them. The internet, and social media in particular, are increasingly becoming a highly customised reflection of ourselves.
One major study of over a million Facebook users (by academics in Italy and at Harvard) confirmed this theory. Here, 270,000 posts on 73 different Facebook pages were classified as to whether they contained scientific news (with 255,225 users) or conspiracy theory posts (790,885 users).
They then measured the engagement with these posts. If a user spent 95% of their time exclusively reading content of one type, then they were deemed to be an isolationist. In the study, 92% of the conspiracists qualified for this tag versus 77% of scientific news consumers. While this in itself would not cause concern, more worrying is the evidence that suggests that false beliefs are rarely able to be corrected once adopted. The study showed that even if false news stories had the word ‘fake’ at the end of the title, it engendered the same engagement as if the word was absent. Meanwhile, just 1.3% would engage with a story that proactively debunked any of the original conspiracy theories, and those that did became even more convinced of the veracity of the original claims!
While this research is of interest, it could become a concern when linked to political outcomes. Here we see the influence of the UK-based company, Cambridge Analytica, the leading commercial exponent of internet-based psychological profiling (now often referred to as ‘psychographic’ analysis). Cambridge Analytica looks to use this new science to help politicians win elections. Its clients include Donald Trump and the (unofficial) Leave.EU campaign.
In the case of Trump, the company mined personal data to evaluate how voters rank on a five-factor spectrum of openness, conscientiousness, extroversion, agreeableness and neuroticism. This was overlaid with electoral rolls to obtain a digital database of voters and likely voting intentions. The objective was to design a system by which a campaign team could craft and deliver specific ad messages tailored to the various voter segments.
Trump’s apparently random tweeting, meanwhile, often used words that were trending on social media at the time of the post and, so, facilitated the widespread dissemination of his latest campaign pledge, hype and ‘news’, or undermined the support for critics and rivals. Real news, sensationalist stories and outright lies intermingle. When such material has an overtly political skew, it can be picked up and targeted at voters.
The striking proportion of inaccurate, and evidently false, claims made by Trump was all part of the package. What might to most of us seem like a step too far – the creation and propagation of fake news stories on the internet – is actually big business. Every click, ‘Like’ or ‘Share’ we indulge in on social media makes a website more attractive to advertisers. Internet-based news sites, in particular, are engaged in a no-holds barred race to the bottom to attract clicks. Real news, sensationalist stories and outright lies intermingle. When such material has an overtly political skew, it can be picked up and targeted at voters. Various sources suggest fake news was able to drown out more considered media content in the run-up to the Presidential election.
The chief executive of Donald Trump’s campaign was Steve Bannon, one of the chief purveyors of internet-based news via his (far) right-wing Breitbart News website. Bannon epitomises the anarchic, anti-establishment streak that characterises some of Trump’s comments. Incidentally, Bannon was, at least until recently, also on the board of Cambridge Analytica. Following Trump’s election success, Bannon recently became Chief Strategist for the White House, a role that gives him access to sensitive state secrets with potentially far-reaching geopolitical consequences.
Here in the UK meanwhile, it is Aaron Banks who is leading a similar charge. The £1m UKIP donor subsequently donated £7.5m to the Leave.EU campaign, funding its use of Cambridge Analytica’s psychographic expertise and electioneering tactics. Banks and Farage travelled together to the US to consult with Trump’s campaign team. Leave.EU used social media to target each segment identified by the psychographic analysis. At the peak of the campaign, messages relentlessly focused on immigration reached 15 million people a week. When someone ‘liked’ the post, they were then contacted by the Leave.EU telesales centre to reaffirm views and "join the cause".
After the referendum, Banks reported on his advice from the Americans: "What they said early on was, ‘Facts don’t work,’ and that’s it. The Remain campaign featured fact, fact, fact, fact, fact. It just doesn’t work. You have got to connect with people emotionally. It’s the Trump success." Banks has since set up the website Westmonster.com, his objective being (as quoted on the Daily Mail’s website) to "drain the swamp of Westminster careerists and corruption".
How do you look beyond the hype? A good rule of thumb seems to be to assess how much the idea of patriotism is used to justify policies.
How do you look beyond the hype? A good rule of thumb seems to be to assess how much the idea of patriotism is used to justify policies, and to decrease or increase your scepticism accordingly.
But what does all this have to do with 7IM’s investment strategy?
The first link is to the increase in allocation to alternatives. These now stand at 20% of our portfolios. Moreover, we are sitting on 13% cash in our Balanced portfolio with a view to moving more of that into alternatives as our extensive and rigorous due diligence process finds suitable opportunities.
This allocation looks to replicate the former role of fixed income in providing a suite of investments that are unlikely to travel in the same direction as equity markets or that are neutral to the reaction of mainstream financial markets to events. We’re also finding that alternatives provide us with strategies that are helpful in combatting a political environment that is fast becoming an ‘alternative reality’.
Also, while Brexit did not have the immediate headline impact on the economy, it has impacted the value of Sterling. This in turn has also led to an increased performance of the FTSE 100 given that approximately 75% of its revenues are from companies’ overseas operations and, therefore, worth more in Sterling terms to UK investors.
We were underweight Sterling around the Referendum and have since used our ability to hedge currency exposure to lock in the gains made on foreign currencies. The ability to take, or hedge, foreign currency exposure is still the primary tool to manage the risk surrounding Brexit, and the chart below highlights how our positions have changed over time.
Managing Brexit via Sterling (Balanced fund currency exposure)
A ‘good’ Brexit (as far as free trade is concerned) would see Sterling rally against other currencies, which would be dangerously bad or ‘red’ for our portfolios given our allocation to foreign currencies (circa 30% of the Balanced strategy) would damage portfolios. A ‘bad’ Brexit, in which Sterling remains at historically low levels, and possibly heads towards the $1.10 mark, would prompt an increase in the value of our foreign currency holdings and support positive returns. How can we position a portfolio to cope with both outcomes?
Our political system means that ‘only’ 37% of the population is needed to win an election, even a small swing of the political pendulum towards the 48% that voted for Remain could have significant political consequences. Remainers are, as yet, a latent political threat but, if they were to coalesce behind their cause, it could prompt the Tory government to reconsider its hard Brexit strategy. After all, the primary goal of any government is to be re-elected.
We have the ability to manage our relative exposure to Sterling and foreign currencies, but this will only address a narrow range of outcomes, rather than the broader uncertainty we are actually facing.
So, to help insure our portfolios against more damaging outcomes (even if these outcomes are relatively unlikely), we took the decision to buy a one-year maturity out-of-the-money call option on Sterling versus the US Dollar.
Managing Brexit via Sterling (Balanced fund currency exposure)
This has the potential to deliver a positive return in the event of a strong Sterling rally over the next 12 months. Spending up to 0.2% of every portfolio on this option, it was struck at $1.45. This is deemed to be significantly “out of the money” as far as the market is concerned and, as it runs counter to conventional wisdom (which has been to hedge against Sterling weakness), it is relatively inexpensive. In the event of a surprise rally in the Pound, our pain would be curtailed.
Another example of how an alternative approach to investments is helping us in an alternative world.
Chief Investment Officer
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