Mere hours after the UK voted by the slimmest of margins to break away from the European Union, International Monetary Fund chief Christine Lagarde sounded a shrill warning that parties need to move swiftly to reduce uncertainties so as rein in risk.
If nothing else, the Brexit referendum – both in the lead up and especially in the aftermath – is a case study in the perniciousness of uncertainty. More than a few headlines have warned that the UK, EU and, by virtue of association, the international community have entered dark, unchartered waters, and that the spectre of uncertainty threatens to stalk markets for the foreseeable future. As one Hong Kong-based private banking head pointed out in a conversation yesterday, “We’re all grappling in the dark because there’s no political or financial playbook for this one.”
Closer to home, it has not gone unnoticed by Asia’s private banking community that their CIOs for the most part failed to pick a winner – or even to simply orient the house towards a possible Brexit outcome.
Indeed, Asian Private Banker’s ongoing Brexit Fallout poll (click here to participate) reveals that CIO house views overwhelmingly missed the mark in terms of predicting a Brexit victory, with 87% (at the time of publishing) of respondents claiming that their respective bank either leaned towards a Bremain result or called it outright.
So an argument could be made (however churlish) that CIOs, whose views shape clients’ investment strategies, fell short in terms of preparing those clients for a potential exit result, or at the very least failed to accurately reflect the probability that a Brexit vote was on the cards.
For instance, Swiss pure play Pictet advised investors that “it may be better to look at the bookies than the polls”, given that the former put the odds of a Bremain scenario at 60-70%, even as the polls were showing a 50-50 split.
Private banking giant UBS offered similar odds in the lead up to the referendum, assigning a 30% chance to the UK exiting premised on the quite reasonable observation that undecided voters tend stick with the status quo.
Citi Private Bank originally put the odds of an exit at 30% before bumping them up to 40% when “notable members of the Tory party … decided to campaign in favour of Brexit”. The only certainty, the bank noted, is “the return of attention to idiosyncratic political risks at some point fairly soon”.
Falcon Private Bank advised that a Bremain vote was likely “due to the power of the incumbency argument”.
And Indosuez Wealth Management went one better, not only forecasting a Bremain scenario, but postulating that the UK “should also adopt the euro” once its citizens had chosen to stick with the bloc. This confidence was reflected in the fact that the private bank was tactically overweight on Euro banks going into the referendum (since the close of markets on 23 June, share prices for the continent’s top five banks by assets have dropped an average of 18.4%).
But CIOs were by no means the only ones to ‘get it wrong’. So did the political pundits and scholars who carve out a living from reading the polling tea leaves; so did the majority Eurozone politicians who were forced to sit through a puerile tirade from UKIP leader Nigel Farage yesterday, and whose goodwill reservoirs must be running dry; and perhaps so did those Bremain supporters who decided to sit out the vote due to torrential rain in the southeast of the country.
Let’s be clear: CIOs are not soothsayers, and with the result blindsiding even the most astute political observers, it would be unreasonable to expect CIOs to get it right where the rest of us got it wrong.
At best these individuals and the banks they represent have a responsibility to accurately identify and communicate the risks of the situation, which means they must take stock of uncertainties. After all, market volatility is a function of what the market knows and what it doesn’t know.
This brings to mind former US secretary of defence Donald Rumsfeld’s unfairly maligned meditation on coping with uncertainty. To paraphrase, there are known knowns, known unknowns and, of course, unknown unknowns – or things we don’t know that we don’t know. The intelligence community necessarily worries about this last kind, even if it cannot be sure that there is anything to worry about in the first place.
Markets, by their very nature, reflect both known knowns and known unknowns in the sense that volatility is determined by the interplay between these two factors (certainty and uncertainty). Unknown unknowns – the most dangerous kind according to Rumsfeld – are perhaps more akin to black swan events insofar as they are outliers that are nigh-impossible to detect, potentially high impact but retrospectively rationalisable.
So where CIOs and their house views could be accused of getting it wrong – at least in terms of the Brexit referendum – is in their ostensive decision to place too much weight on potentially flawed polling practices (e.g. phone vs internet polling) and voter behaviour models that are ill-equipped to account for the idiosyncrasies of a situation in which the heart has usurped the head.
At which point CIOs are liable to turn around and ask, “What else can I go by if not the pre-polls?”. There is no obvious answer to this question, but then, to reiterate, there is no onus on CIOs to play the fortune teller and come down either side. They only need to delineate and communicate the uncertainties. Easier said than done, of course, but that’s why they’re paid the big bucks.