Grexit & Current Volatility

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"Markets are selling off due to the uncertainty regarding the outcome of the Greek referendum that has been called for this upcoming Sunday. The government hopes that the referendum will be viewed as a vote to stand up against the exploitative creditors (No) or in favor of compromising and accept the creditors demands (Yes).

NAI (“yes”)
If the yes vote wins, there is a big question mark surrounding what exactly this will mean given that the proposals on which Greeks are voting will have expired. This Greek crisis was never about the specific proposals and the exact savings generated—it has always been about politics. If Tsipras continues to recommend the people vote no and the yes vote wins, he will have little choice but to resign. The leader of the next biggest party, New Democracy (ND), would be given a mandate to form a government by the President. It seems most likely a government of national unity will be formed - If there is a government of national unity, the creditors will be willing to negotiate a deal. The terms of that deal will no doubt be worse than the proposal currently on the table, given that the Greek economy and (crucially) tourism revenues will be down significantly by then.

OXI (“no”)
A no vote in the referendum will have even more dire consequences for Greece than a yes vote. Prime minister Tsipras seems to think a no vote means Greece can negotiate with its creditors. He seems to have missed a very important memo though: Merkel is done with Tsipras. The only way the Greek government is going to get a deal is if it is a different Greek government from the current one. Instead, a no vote will most likely result in a Grexit. One potential trigger for a Greek exit from the eurozone could be social unrest. Greek civil servant wages are paid in the middle and end of each month, and pensions are paid at the end. The Greek government does not have any remaining funding for public sector wages and pensions. The Tsipras government could pay civil servants in IOUs or a parallel currency for a while, but eventually public sector workers may revolt and demand to be paid in a currency with which they can also pay their taxes. IOUs or a parallel currency are also insufficient because of the state of Greece’s banks.

OUR Reality
The market sell-off highlights that the investment community is unsure what either vote will have on the capital markets and the spill-over of a Greek default on European Sovereign Bonds, European Equities and global asset classes. The chart below highlights who Greece owes money, we know with better visibility, who is owed what. Unfortunately, we can not quantify the 'unknown' risks - For example, Italy 10 year bonds +0.23% to 2.38% and Spanish +0.21% to 2.32%, today, what impact is this drastic move having on the holder of these bond's balance sheets who may have to mark to market, and take paper losses. Will a holder have to raise capital, what impact could this have, etc.. With the flight to safety into US$ and Yen (safety currencies), what impact could this have on capital market flows?

Over the past couple of months, we have advocated taking some profits in our equity allocations and reallocating to fixed income given our view of increased volatility due to Greece and the Federal Reserve raising rates. Despite the volatility, we continue to be very comfortable with our asset allocation and fund allocation. It is important in this environment to look at our fund holdings from a big picture perspective and ask ourselves, is the weakness due to sentiment (Greece) or fundamentals (recessions). Sentiment driven sell-offs are wonderful opportunities to re-enter the market as was the example in 2011. We believe that volatility in Greece will have little long term impact on our funds due to their bottom up, credit focused approach to investing. The prices of the companies that we have purchased will be impacted by sentiment, but their underlying businesses will be much less impacted. From a sovereign bond perspective, our global allocation are to areas with rock solid fundamentals and credible monetary policy. It's important to note, that within our Strategic Income Fund, we had 0% allocation to core Europe, with 4% allocated between Sweden and Norway - this speaks highly of the team's credit work and investment management expertise.

The volatility in the European markets and over the past weeks highlights the key points that we have been advocating over the past year of the risks inherently embedded in the European Equity and Fixed Income Markets. Given the unknowns to any potential outcome, we continue to be cautious on Europe and favor other markets on better fundamentals, cheaper valuations and less 'phone call' risk including but not limited to United States equities which are selling off on sentiment, and not fundamentals. Yes, the upcoming week will be volatile, but we have been waiting for this opportunity for quarters and look forward to adding to companies and sovereign bonds, with strong balance sheets, strong underlying fundamentals which are now trading at cheaper valuations."