The potential impact of a Brexit
By John Wyn-Evans, head of Investment Strategy at Investec Wealth & Investment
What impact could Brexit have on assets and on currencies and how should portfolios be positioned? A study undertaken by Capital Economics of various surveys into the effects of Brexit on the economy showed, over an unspecified forecast horizon, that there was a gap of 22% of Gross Domestic Product (GDP) between the most extreme views.
Bearing in mind such uncertainty and the difficulty that even professional investors will have making sense of such information, it seems only natural that market participants will demand a higher risk premium until the outcome becomes clearer.
That would suggest some underperformance of UK assets relative to overseas assets in the immediate short term. Additionally, a vote to leave will involve new trade agreements, not only with the EU, but also with other trading partners, the latter of which could take several years to complete.
Other separatist movements, for example, in Scotland and Catalonia, might have the potential to create further disruption. The uncertainty will only end if voters choose to stay.
Impact on sterling
A vote in favour of leaving the EU would be distinctly negative for sterling because of its potential to impact the economy and international trade. It is also distinctly possible that UK-based investors will look to hedge their risks by taking money out of the country, adding to the pressure.
Several high-profile investment banks have suggested that the pound could lose between 10 and 15% of its value in the event of Brexit based on experience during the financial crisis of 2008. That seems too high a risk to ignore.
However, a full blown crisis is unlikely to be on the cards. The fiscal position is improving and the country is solvent. There is also a self-correcting mechanism built into a falling pound in that the trade balance will improve and income from overseas assets will also be boosted in sterling terms. On balance, though, the pound will continue to trade weaker in our opinion.
Impact on bonds
Looking at other asset classes the main positive factor impacting the performance of UK government bonds is that, whatever the result, it will still be the same government in charge, meaning a perceived safe hand on the tiller and a commitment to balancing the budget.
The outlook for interest rates and inflation will have the most profound effect on gilts. The UK is a very open economy and prone to bouts of inflation, especially in response to a weak pound. Yields could rise in the face of higher inflation, exposing investors to capital losses with limited income to make up that loss.