Planning for political uncertainty

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By Nick French, head of UK Wealth Management at Russell Investments, on the uncertainty surrounding the outcome of the UK general election and ensuring that clients investments are not subject to unnecessary risk.

Taking a directional view on the outcome of the election is at best difficult and seems likely to hinge as much on luck as good judgement. There is a lot more water to flow under the bridge before the election and the minor parties will have a significant role. Even if we did have conviction in a particular political outcome, it is even harder to translate that into short or medium term market effects.

Our preference is to ensure that our clients’ portfolios remain invested in a manner that does not expose them to unnecessary and unrewarded risk. This sentiment is key to how we are approaching the UK General Election. The one thing we can be reasonably sure of is that the volatility in domestic markets and sterling will increase as a result of the election uncertainty. This increase in volatility is already beginning to manifest itself in option implied volatility across asset classes.

From our vantage point, it is not clear that the market is pricing in the full extent of the uncertainty or a long enough window. It seems likely that volatility, particularly in sterling, could be more pronounced and last for a longer period of time after the election date.

The stage is set and the actors are warming their voices but the script of this election is far from written. While it would be foolish to try to make predictions about the outcome of the 2015 election, that doesn’t mean we can ignore it either. In the management of our client portfolios towards their balance sheet objectives, there are two things we are doing.

Firstly, we are watching the volatility markets. It is here that we can begin to see how different asset classes are pricing the election uncertainty. By comparing implied volatility domestic asset classes with international markets, we can see if any domestic markets are decoupling from the international pack.

Secondly, we are limiting the exposure to the directional outcome of the election. With no clear outcome and further uncertainty about how markets might respond, there are better risk adjusted returns available. In time, the uncertainty of the election may impact asset prices (and most likely sterling) to offer attractive opportunities. Until then, we’ll watch the play begin to unfold.

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