By Hoshang Daroga, Portfolio Manager of Copia Capital Management
With less than six months to go till Brexit, investors are getting increasingly nervous about the markets and the impact on the UK economy. With every day bringing new developments, it’s almost impossible to predict the final outcome. Deal or No Deal? It’s a tough one to call. You have to feel for the Prime Minister, attacked from all sides, even from within her own party, with political gain often a more eagerly sought prize than the country’s greater good.
It has to be said that whilst it’s Brexit that looms large in our thoughts here in the UK, elsewhere it’s the trade war between China and the US that’s seen as the big threat to the global economy. All the same, giving some thought to how different types of assets could potentially behave in a Hard/No Deal Brexit can help us make informed investment decisions.
Sterling: Since the referendum, the market has continued to use Sterling to express its views on Brexit developments. A Hard/No Deal Brexit is expected to be bad for the economy, leading to further depreciation of the Pound Sterling from current levels. A Soft Brexit would be a better outcome for the UK economy, leading to some appreciation of Sterling from current levels.
UK Exporters: Any depreciation of the currency improves outlook for UK exporters as their Sales value rises, leading to better profits, likely causing a rise in share prices for UK stocks that derive their revenues from exports.
Non-UK investments: Another indirect beneficiary of a Hard/No Deal Brexit would be investments in equity markets outside the UK (such as US or European Equities). In a foreign market, UK investors convert their Pounds to the other currency. If the Pound were then to depreciate vs this foreign currency, the UK investor would get back more Pounds once the asset is sold. Consider the following example: a UK Investor invests £100, buying US shares worth $130 at an exchange rate of $1.30/Pound. Now assume the Pound depreciates to $1.10/Pound while the price of US shares remains the same at $130. In US Dollar terms the investment is still the same at $130, but in Pound terms the investment is now worth ~£118, with the UK investor realising a profit of £18.
UK Importers: On the downside, a Hard/No Deal Brexit may slow down economic growth in the UK as businesses adapt to the new rules and regulations and to potentially higher costs and duties imposed on traded goods/services. A slowdown would also have a direct impact on real asset prices as investors become reticent to commit capital for the long term.
UK Inflation: Finally a weaker Pound Sterling would make imports more expensive; prices for consumer goods may increase as companies pass on the increased costs to the consumer, causing a temporary jump in inflation.
These are just some of the potential movements of various investments in a Hard/No Deal Brexit scenario. Given the progress the UK has made with the EU, there still is a strong potential for the UK to secure a deal, in which case none of the above may occur.
It is practically impossible for anyone to predict how investments will behave in the face of Brexit, but what we can do is take steps to ensure investments are made correctly to withstand most potential outcomes.
It’s only natural in the current climate of uncertainty that investors would feel the urge to sell their investments and sit it out in Cash. Sadly, while some investors will inevitably dive for cover in this way, being in Cash may not be the best strategy; instead it could very well be the worst thing to do. In a Hard/No Deal scenario, holding Cash would mean severe loss of purchasing power if Sterling depreciates. The Pounds you hold would be worth much less all around the world; all future travel outside the UK would become more expensive, as would imported household products. In essence, UK investors holding Cash would find themselves suddenly able to afford much less than they could pre-Brexit.
But what if a deal is struck in the nick of time? In that case so-called risky assets like Equities would rally as the economic outlook brightens. Again, holding Cash would only mean lost opportunity, and potential loss of value through inflation, compared to those who had remained invested.
This means holding Cash is most likely a no win situation for investors going into Brexit, although the potential trade war needs to be factored into thinking.
We at Copia believe the best course of action is to stay invested in a diversified portfolio comprised of multiple asset classes like Stocks, Bonds, Commodities and Real assets not just in the UK but across multiple geographies in multiple currencies. Such portfolios are no longer the preserve of institutional investors; they are readily available for retail clients at competitive prices.
A well-diversified portfolio is not only capable of providing stable long term returns – maintaining purchasing power – but can also mitigate unrewarded risk, preserving capital.