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Strategy

What would a Brexit mean for investors?

What would a Brexit mean for investors?

Tuesday 24th May 2016

With the UK's future in Europe to be decided next month, what would its departure mean for investors? Emma Cusworth finds out.

As the UK’s ‘in’ or ‘out’ vote on membership of the European Union on 23rd June looms large over the domestic market, the polls remain deadlocked and the outcome will be a close-run race.

While many in the city maintain a core ‘in’ scenario, the chances of an ‘out’ vote have increased and investors need to carefully consider the consequences of leaving the EU on their asset/liability mix.

Uncertainty is the name of the game. No country has ever left the EU before, so there is little real understanding of what to expect following a ‘no’ outcome. The nearest comparison would be Greenland’s 1985 ‘soft’ exit that left it as an associate member, still subject to EU treaties, but the UK would be highly unlikey to accept a similar arrangement.

The lack of a recent precedent leaves it very unclear what the consequences of a Brexit would be.

UNCERTAINTY IS THE ONLY CERTAINTY

Roger Bootle, managing director of Capital Economics, speaking at the Pensions and Lifetime Savings Association Investment Conference 2016, said: “The fact of the matter is there aren’t facts. There are assumptions, there are views, there are factoids you can push or bend in a certain direction, but this is not something where you are going to get the objective truth.”

Capital Economics’ analysis of various surveys into the economic effects of Brexit revealed a 22% difference in projected gross domestic product (GDP) between the most extreme views. The high level of uncertainty this gap reveals is itself having, and will continue to have, an interesting effect on institutional investors, both on the asset and liability side of their balance sheets. And not all of that is bad news.

Bill Street, head of investment (CIO) EMEA at State Street Global Advisors, says the referendum is “undoubtedly the key risk event facing the UK this year”.

He adds: “The perceived risk of Brexit is likely to generate increased uncertainty in the markets, adding to current market concerns.”

Uncertainty manifests itself through greater volatility and an increase in the riskpremium demanded by investors, which, in turn, pushes down asset prices.

STERLING JITTERS

As the most liquid sterling asset, the pound is first to suffer the effects of greater uncertainty and has already taken a beating. Immediately after the Prime Minister’s announcement of the referendum date at the end of February, sterling fell 0.9% to a seven-year low against the dollar. It has since recovered some of those losses, but is clearly sensitive to the on-going Brexit issue.

GBP pairs dropped some 7% over a period of six weeks when David Cameron first promised to go to referendum, according to Clear Treasury, and Boris Johnson announcing for the ‘out’ campaign on Sunday 21 February saw GBP pairs almost 1% lower versus their Friday close.

Jean Medecin, member of the investment committee at Carmignac, believes sterling remains the “weakest link where Brexit is concerned”. “It’s already softened as the prospect of Brexit seemed to increase. If that trend continues sterling will suffer more,” he says.

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