What would a Brexit mean for investors?

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

Features

Web Share

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

Markets would naturally demand a higher risk premium on long-dated gilts as a result of this increased uncertainty. Furthermore, the open nature of the UK economy leaves it prone to inflation, especially in the face of a weaker pound, which could also support higher yields.

As deflation remains the greater existential threat, the Bank of England may find it harder to raise rates in the short term and is ready to continue with its accommodative policy to support the economy. This could result in a steepening of the yield curve as short term rates continue to be suppressed by the central bank.

The same may not be true of the medium term, however. Quantum’s Davies says: “Some pundits worry that the sand Brexit throws at the machine will reduce trade across the North Sea, thereby diminishing returns in general and holding down base rates for longer. But equity investments are frequently global and UK rates might find it hard to detach themselves too much from the US.

“Matching portfolios can be left as they are,” Davies continues. “If gilts fall, liability values fall, etc. Return-seeking portfolios should remain spread across the globe and across return seeking asset classes. The big question is whether duration hedges should be increased in case ‘lower-rate doomsayers’ are correct. We don’t think Brexit should be the driving force here; at current rates, the insurance doesn’t look cheap.”

LEGAL UNCERTAINTY

Although the impact of a Brexit would be felt primarily through macroeconomic and political uncertainty, there are also significant concerns regarding the investment legal structure. An ‘out’ vote could have meaningful ramifications on the investment landscape, causing disruption and heightening uncertainty for institutions.

“Generally legal obligations will remain enforceable and the choice of governing law provisions will continue to apply and be respected within the continuing EU member states,” according to DLA Piper finance partner, Vincent Keaveny. However, he warns there will be numerous consequences that flow from the detail of EU legislation that will impact on particular sectors of the market and categories of investments.

Covered bonds issued by UK banks, for example, would cease to be eligible for inclusion in an UCITS fund because of the requirements of the UCITS directive that qualifying covered bond issuers have their registered offices in the EEA.

“Restrictions of this kind appear through much EU legislation,” Keaveny says. “It is not clear that issuers and investors have yet begun to determine the full extent of the impact these detailed provisions will have on the instruments they issue or hold and the potential disruptive effect that these restrictions would have on the trade-abilty and pricing of those instruments.”

Undoubtedly, the consequences of a Brexit would be far-reaching. While an ‘in’ vote would likely lead to a short relief rally as uncertainty dissipates, allowing investors to capitalise on buying opportunities thrown up by the volatility preceding the vote, an ‘out’ vote would have more lasting implications that are yet to be fully understood. There are silver linings to a departure from the EU, not least the potential that gilts yields could rise, providing much needed relief on the liabilities side, while the increasing exposure to foreign assets could bring benefits from a weaker pound.

One thing is certain, however. Uncertainty will prevail until the result is in.

“The outcome is so finely balanced  not even Mark Carney can predict it,” Quantum’s Davies says. “Markets hate uncertainty of any kind and this could throw up buying opportunities for those who are ready to strike. Above average cash might help investors capitalise on this.”

 

 

WHAT ADVICE WOULD YOU GIVE TO INSTITUTIONS IN TERMS OF

ANY NECESSARY ACTION OR CONSIDERATIONS IN THE LEAD UP

TO THE VOTE?

Bill Street, head of investment (CIO) EMEA at State Street Global Advisors: “Regarding sterling, where we have seen the greatest moves year-to-date, we don’t see this as a value opportunity yet. Sterling has been weakening since the start of this year, and much of this move may simply reflect the later timing of expected rate hikes in response to the weaker growth outlook. While the SSGA currency team have scaled back an underweight position in GBP, we still remain modestly underweight due to shorter-term models of interest rate expectations.”

Declan McEvoy, CEO at Coalface Capital: “Review the asset/liability mix to reduce the level of exposure to volatility in the FX rate, but wait and see after that – the long term impact of an in vote is a much narrower range of outcomes than the impact of a Brexit, but so long as the asset and liabilities are reasonably well matched in terms of currency denomination and maturity, there will be time afterward to reassess.”

Léon Cornelissen, chief economist at Robeco: “It is important to keep a cool head as, firstly, an ‘in’ outcome is the more likely scenario, secondly, the timelines after an ‘out’ outcome can turn out to be long. In the ‘out’ case there is no need for the UK government, most likely under a new leadership, to immediately invoke article 50 of the Lisbon Treaty which would trigger a maximum of two years for discussions on the terms of divorce. It could prefer to buy more time or even push for a new referendum on other terms. Nevertheless, it would be sensible for institutions to make a scenario analysis on the short and long term consequences of an ‘out’ outcome as from a UK point of view the external environment would eventually most likely worsen.”

More Articles

Subscribe

Subscribe to Our Newsletter and Magazine

Sign up to the portfolio institutional newsletter to receive a weekly update with our latest features, interviews, ESG content, opinion, roundtables and event invites. Institutional investors also qualify for a free-of-charge magazine subscription.

×