Brexit and Your Portfolio

Whichever way one voted, it is hard not to be dismayed by the shambles that is Brexit, concocted by all sides. In the event that any deal agreed gets voted down in Parliament, or there is no deal, there is a material chance that the government could fall. One or both of these events would come with great uncertainty.

We set out three key investment risks relating to Brexit and how sensible portfolio structures can mitigate them.

Risk 1: Greater volatility in the UK and possibly other equity markets

In the event of a poorly received deal or no deal, it is certainly possible that the UK equity market could suffer a market fall as it tries to come to terms with what this means for the UK economy and the impact on the wider global economy.  A collapse of the Conservative government and a Labour victory would add further uncertainty.

Risk 2: A fall in Sterling against other currencies

In 2016, after the referendum, Sterling fell against the major currencies including the US dollar and the Euro.  There is certainly a risk that Sterling could fall further in the event of a poor/no deal.

Risk 3: A rise in UK bond yields (and thus a fall in bond prices)

The economic impact of a poor/no deal and/or a high-spending socialist government could put pressure on the cost of borrowing, with investors in bonds issued by the UK Government (and UK corporations) demanding higher yields on these bonds in compensation for the greater perceived risks. Bond yield rises mean bond price falls, which will take time to recoup through the higher yields.

Mitigant 1: Global diversification of equity exposure

Although it is the World’s sixth largest economy (depending on how you measure it), the UK produces only 3% to 4% of global GDP, and its equity market is around 6% of global market capitalisation.  Well-structured portfolios hold diversified exposure to many markets and companies.  Changing your mix between bonds and equities would be ill-advised.  Timing when to get in and out of markets is notoriously difficult. Provided you do not need the money today, you should hold your nerve and stick with your strategy.

Mitigant 2: Owning non-Sterling currencies in the growth assets

In the event that Sterling is hit hard, it is worth remembering that the overseas equities that you own come with the currency exposure linked to those assets.  Remember too that a fall in Sterling has a positive effect on non-UK assets that are unhedged.  The bond element of your portfolio should generally be hedged to avoid mixing the higher volatility of currency movements with the lower volatility of shorter-dated bonds.

Mitigant 3: Owning short-dated, high quality and globally diversified bonds

Any bonds you own should be predominantly high quality to act as a strong defensive position against falls in equity markets.  Avoiding over-exposure to lower quality (e.g. high yield, sub-investment grade) bonds makes sense as they tend to act more like equities at times of economic and equity market crisis.

Some thoughts to leave you with

Even if you cannot avoid watching, hearing or reading the news, it is important to keep things in perspective.  The UK is a strong economy with a strong democracy.  It will survive Brexit, whatever the short-term consequences that we will have to bear, and so will your portfolio.  Keeping faith with both global capitalism and the structure of your portfolio and holding your nerve, accompanied by periodic rebalancing is key.  Lean on your adviser if you need support.

‘This too shall pass’ as the investment legend Jack Bogle likes to say.

Other notes and risk warnings

This article contains the opinions of the authors but not necessarily Donald Wealth Management (the Firm) and does not represent a recommendation of any particular security, strategy or investment product. Information contained herein has been obtained from sources believed to be reliable, but is not guaranteed. It is not a promotion of Donald Wealth Management’s services. Donald Wealth Management strongly suggests that no investor should act on any of these ideas without first seeking financial advice.

Past performance is not indicative of future results and no representation is made that the stated results will be replicated. The value of an investment is not guaranteed and on encashment you may not get back the full amount invested. Errors and omissions excepted.

Donald Wealth Management is a trading style of Donald Asset Management Limited which is authorised and regulated by the Financial Conduct Authority in the United Kingdom (FRN: 223784). Donald Asset Management Limited is registered in England and Wales under Company No. 4675082. The registered office address of the Firm is: Stable End, 12 Heather Court Gardens, Four Oaks, West Midlands, B74 2ST.

So it is ‘leave’

BrexitThe people of the UK have woken up this morning to a vote to leave the EU, the Prime Minister is set to leave office in October and the markets are suffering a bout of jitters. We all knew that these were possibilities. To some this is a good day, to others it is not. But we are where we are and we need to look forward to where we go from here.

We should not, however, lose sight of the fact that what we have witnessed is a long-standing, robust and stable democracy at work with both sides attempting to sway voters with the power of argument, passion and belief. Although we have seen some dubious use of facts and figures, some scaremongering on both sides and some less than savoury comments at the fringes, this process has been free of violence, open to all and with everyone’s vote holding the same sway; that we should be both proud of and reassured by.

We are also seeing the markets at work, trying to make sense of what this all means and reflecting the aggregate view in market prices. We are likely to see market gyrations over the coming weeks and months, but we should all remember to view it as short-term noise. There are many ‘known unknowns’ as Donald Rumsfeld would say: we face an uncertain and likely tough negotiation to exit the EU, with an unknown outcome; an increased likelihood of another Scottish referendum and threat to the Union; and the knowledge that broad change is upon us.

As individual’s we need to try not to worry about things that we can’t control, such as what will happen to the UK economy over the next five years, or where the markets go in the next few days, weeks and months. We should focus on things that we can control such as the structure of our investment portfolios. As we have explained before, your portfolio is well positioned to weather this storm, both in its structure and the high quality funds that we recommended to execute your portfolio strategy with. To reiterate:

Your portfolio is global diversified in terms of its equity exposure

It is worth remembering that the UK economy represents less than 5% of global GDP, and its equity market is around 6% of global market capitalisation. The stock market is also not a direct proxy for the UK economy as many of its constituents have considerable overseas operations, such as HSBC and Shell. In fact, around 70% of earnings from FTSE 100 companies come from overseas.

Your portfolio has well-diversified exposure to other developed equity markets and emerging markets economies and companies, which will help to mitigate any UK-specific market fall. Equity markets as a whole might be volatile, but that is the nature of equity investing, and being diversified will help.

A fall in Sterling is actually beneficial to portfolio performance

This morning has seen a big fall in Sterling against the US dollar and the Euro. Ironically, this fall is beneficial to your portfolio as the non-Sterling denominated overseas assets that you own are now worth more in Sterling terms. That is an example of good diversification in action.

Owning short-dated, high quality global bonds delivers strong defensive qualities

The primary defensive assets in your portfolio are short-dated, high quality bonds, diversified on a global basis. At times of market uncertainty, money tends to flood from more risky assets (equities and low quality bonds) into high quality bonds, driving yields down and prices up. We have already seen early signs of this happening in the major bond markets this morning.

Have faith in your portfolios and resist the urge to look at its value too often. You don’t need this money today or tomorrow, so try not to worry about any short-term falls; that is the nature of investing. This is a long-term strategy to meet your long-term goals.

As the dust settles on what is a momentous day for the UK and the EU, perhaps we should remember that almost an equal number of people voted to remain as to leave. We now all need to find ways in which we can help to rebuild bridges with the other side in whatever small way that we can. The UK has a proud past, a strong present, and an exciting – if different – future to that envisaged by many when they went to bed yesterday. Remember, we are the World’s fifth largest economy with more people in employment than ever before, one of the longest and most stable democracies, and we are an educated, tolerant and open society capable of making the UK a huge success. The vote is what it is and we all need to think how we can contribute to make this happen.

 

Other notes and risk warnings

This article is distributed for educational purposes and should not be considered investment advice or an offer of any security for sale. This article contains the opinions of the author but not necessarily Donald Wealth Management (the Firm) and does not represent a recommendation of any particular security, strategy or investment product. Information contained herein has been obtained from sources believed to be reliable, but is not guaranteed. It is not a promotion of Donald Wealth Management’s services.

Past performance is not indicative of future results and no representation is made that the stated results will be replicated. The value of a unit linked investment is not guaranteed and on encashment you may not get back the full amount invested. Errors and omissions excepted.

Donald Wealth Management is a trading style of Donald Asset Management Limited which is authorised and regulated by the Financial Conduct Authority in the United Kingdom (FRN: 223784). Donald Asset Management Limited is registered in England and Wales under Company No. 4675082. The registered office address of the Firm is: Stable End, 12 Heather Court Gardens, Four Oaks, West Midlands, B74 2ST.

The outcome of the Referendum and your portfolio

The impact of a leave vote on your portfolio

Brexit & EU ReferendumAs the referendum to remain in, or leave, the European Union draws near, we thought it would be a useful time to touch base and provide some reassurance that the investment portfolio that we look after for you is well positioned to weather any investment storms ahead.

In this brief note, we raise a number of potential risks that exist and how these are mitigated, to a large extent, by the current structure of your portfolio.  We do not seek to analyse the debate, provide our slant on it, or steer you in any direction.  We do, however, encourage you to vote as part of our robust democracy – in whatever way you see fit – because a high turnout gives legitimacy to the vote, dilutes extreme views and provides you with the right to complain, if the vote goes against you.

How did we get to this?

There is no doubt that the decision that UK voters will make is a big one, with material consequences for the long-term nature of who/what we want to be as a nation.  It is by no means an easy decision and is made no easier by the polarised positions of both camps that has resulted in unedifying personal attacks, the loose use of data, personal ambition and party division.

Today’s referendum is a long way from the heady days of 1973 when the UK – urged on by Ted Heath – became a fully paid-up member of the European Economic Community (EEC), by an emphatic margin of two to one.  It may surprise some that back then those pushing for entry were the Tories and it was the Labour Party that was riven with in-fighting.  Thatcher’s EU budget rebate in 1985 – which still rankles with some – and our short-lived membership of the Exchange Rate Mechanism in 1992, were early milestones in the up-and-down relationship between the UK and the EU.

Despite the EU’s faults and challenges – not least the future of the Euro and coping with mass migration – it is easy to overlook the fact that, in all of its guises since the Treaty of Rome in 1957, the EU has been central to co-operation and peace between the nations of Europe, extending the principles of democracy and tolerance to its expanded ex-Soviet bloc members.  That in itself is quite an achievement not to be dismissed – or risked – lightly.

How does all this relate to your portfolio?

Much has been written in the financial media about the need to position investor portfolios for a vote to leave (Brexit).  Yet that presupposes that we, as your advisers (or any other investment professional for that matter) can, in some way, foresee what is going to occur and thus reposition your portfolio accordingly.  It also presupposes that BREXIT is a bigger risk to your portfolio than, say Putin’s increasing militarism, the enduring tragedy of events in the Middle East, North Korea’s nuclear sabre rattling, Donald Trump becoming the next US president, or some other geo-political event or natural disaster that we cannot foresee.

When we established your portfolio, we did so knowing that any number of such events would be likely to occur with monotonous regularity over the time you will be invested.  The aim therefore is not to try to reposition the portfolio for each such event – remember that the market’s view of potential outcomes is already reflected to some extent in market prices – but to build a robust, well-diversified portfolio to weather all investment seasons, with an appropriate level of risk for you, and to stay the course.

That said, we believe that there are short-term market risks to a vote to leave the EU that are worth understanding, which we highlight below:

Risk 1: Greater volatility in the UK (and other) equity market

It is certainly possible that the UK equity market could suffer increased volatility – including a market fall – as the market tries to come to terms with what this means for the UK economy and the impact on the wider global economy.

Risk 2: A fall in Sterling against other currencies

Much has been made of a fall in Sterling against other global currencies, which has already been reflected to some degree in exchange rate movements since the start of 2016.  For example, Sterling has fallen from 1.48 against the US dollar to 1.45 and from 1.36 to 1.27 against the Euro.

Risk 3: A rise in UK bond yields (and thus a fall in bond prices)

The Chancellor, amongst others, has stated that the cost of borrowing might rise as investors looking to hold bonds issued by the UK Government (and UK corporations), will demand higher yields on these bonds in compensation for the greater perceived risks of the uncertainty surrounding the decision to leave the EU.

Looked at in isolation, these may appear to be significant risks.  Yet as part of a well-diversified and sensibly constructed portfolio, their impact can be greatly reduced.

Mitigant 1: Global diversification of equity exposure

It is worth remembering that the UK economy represents less than 5% of global GDP, and its equity market is around 6% of global market capitalisation.  The stock market is also not a direct proxy for the UK economy as many of its constituents have considerable overseas operations, such as HSBC and Shell.  In fact, around 70% of earnings from FTSE 100 companies come from overseas.

Your portfolio has well-diversified exposure to other developed equity markets (e.g. the US, Japan, Germany and Australia) and emerging markets economies and companies (e.g. Taiwan, China, India and South Korea), which will help to mitigate any UK-specific market fall.  Equity markets as a whole might be volatile, but that is the nature of equity investing, and being diversified will help.  Changing the mix between bonds and equities would be ill-advised.  Provided you do not need the money today – which you do not – you should hold your nerve and stick with your strategy.

Mitigant 2: Owning non-Sterling assets and currencies in the growth assets

In the event that Sterling takes a beating, it is worth remembering that the overseas equities that you own come with the currency exposure linked to those assets.  For example, owning US equities comes with US dollar exposure, as we do not hedge the exposure out.  If the Pound falls e.g. against the US dollar, these US assets are now worth more in Sterling terms, thus mitigating the fall in Sterling to some extent.  In short, a fall in Sterling has a positive effect on non-UK assets that are unhedged.

The bond element of your portfolio has no non-Sterling currency exposure to avoid mixing the higher volatility of currency movements with the lower volatility of short-dated bonds.

Mitigant 3: Owning short-dated, high quality and globally diversified bonds

The primary defensive assets in your portfolio are short-dated, high quality bonds, diversified on a global basis.   Short-dated bonds are less volatile than longer-dated bonds and their prices will be less affected by any rise in yields.  High quality bonds, tend to be where money flows to at times of equity market trauma, driving yields down and prices up, at least in the short term.  Your bond holdings are also diversified across a number of different global bond markets, which mitigates the risk of a rise in UK yields (and thus falling prices), as the cost of borrowing in other markets will not be impacted in the same way.

Sticking to your strategy

At times like this, it is easy to become overly concerned about near-term events, such as the outcome of this referendum.  Your life as an investor will inevitably be punctuated by an ongoing series of near-term events, making life continually uncomfortable, unless you view them in context.  Below we reiterate a few thoughts that might be helpful.  Remember:

  • The value of your portfolio simply tells you how much money you would have if you liquidated your portfolio today, which you have no intention of doing. You only make actual losses if you sell assets.  If you don’t sell them, they remain in your portfolio to deliver future returns.
  • Your portfolio has a well-thought-out structure – as we explored above – that has been designed to provide you with the best chance of a favourable long-term investment experience. Stick with it.
  • Some assets will be doing well at times and others less so. No-one knows which asset(s) it will be at any point in time.  Markets work well enough to make jumping from one asset class to another a dangerous gambling strategy.
  • Your adviser cannot control what markets do, nor can fund managers. Markets will do what they do.
  • If you anticipate needing any withdrawals from your portfolio in the short term (that we haven’t yet planned for) please feel free to speak to us to discuss your requirements, so we can decide when best to draw them.

Whether your inclination is to remain or leave, try not to worry too much about the consequences on your portfolio as you are well-positioned to weather any storms.  ‘This too shall pass’, as the investment sage John Bogle has said many times before at other seemingly concerning times.

Do not forget to vote.

Other notes and risk warnings

This article is distributed for educational purposes and should not be considered investment advice or an offer of any security for sale. This article contains the opinions of the author but not necessarily Donald Wealth Management (the Firm) and does not represent a recommendation of any particular security, strategy or investment product.  Information contained herein has been obtained from sources believed to be reliable, but is not guaranteed. It is not a promotion of Donald Wealth Management’s services.

Past performance is not indicative of future results and no representation is made that the stated results will be replicated. The value of a unit linked investment is not guaranteed and on encashment you may not get back the full amount invested. Errors and omissions excepted.

Donald Wealth Management is a trading style of Donald Asset Management Limited which is authorised and regulated by the Financial Conduct Authority in the United Kingdom (FRN: 223784). Donald Asset Management Limited is registered in England and Wales under Company No. 4675082. The registered office address of the Firm is: Stable End, 12 Heather Court Gardens, Four Oaks, West Midlands, B74 2ST.