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 un-hedged. 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.