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Trevor Greetham: Preparing for the Brexit endgame

Although a ‘known unknown’, an EU exit has the power to move markets in a major way

Trevor-Greetham-700x450.jpgBrexit is the gift that keeps on giving when it comes to uncertainty.

Two years on from the EU referendum and the rocky passage of the Withdrawal Bill has left many questions unanswered.

Cabinet splits give the impression the UK has not finalised its own negotiating position.

The difficulties of a minority government might mean no majority to approve a final deal. And time is running short with the “difficult” part of the negotiation – speaking to the other people -still ahead.

As multi-asset investors, we think it is important to focus on practical steps investors can take to lower the sensitivity of their portfolios to Brexit risk.

On the plus side, there is a time limited nature to Brexit risk. The UK needs to agree an exit deal by March 2019 in order to have a transitional period, without which cross-border trade will face a cliff edge.

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But things are likely to get worse before they get better as there is high stake brinksmanship at play. The prime minister has said the UK must be able to walk away from the negotiation table in order to get the most favourable deal. No deal is better than a bad deal, we are told, although few in business believe it.

While politicians have been engaged in debating what constitutes a “meaningful” vote, Airbus, Siemens and BMW have said a “no deal Brexit” could force them to shift production abroad – and that this may also be the case in an orderly transition to a Brexit outside the Customs Union in which frictionless cross- border trade cannot be guaranteed.

Meanwhile, UK Finance says a breakdown in cross-market financial services could result in the loss of up to 75,000 jobs. Other warnings are sure to follow. Listed companies have an obligation to inform their shareholders of material risks to their business and insider trading rules mean they cannot legally keep this information out of the public domain.

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Risks point in both directions, however. The more likely a disruptive Brexit outcome becomes, the more likely it is that there will be a reaction against it. Recently more than 100,000 people gathered in London to demand a referendum on the final deal. If public opinion shifts and parliament blocks a deal, there are many possible outcomes.

The UK could end up in a never-ending transition period, effectively retaining full single market membership for its service sector and the City. It could join the European Economic Area alongside Norway. It could even end up staying in the EU if another referendum reverses the result.

We are not saying any of these outcomes is likely. That’s the point. No outcome seems overwhelmingly likely but something has to happen. Experience to date suggests key issues will remain unresolved until the last possible moment and investors will have to remain open to all possibilities.

Sterling could easily be 10 per cent lower on a no deal Brexit and it could easily strengthen by 10 per cent if the UK ends up in an unexpectedly close relationship with the EU. Sudden swings in sterling can have a major impact on multi-asset portfolios as we saw in 2016. We have three practical pieces of advice.

First, investors need to accept that it is going to be very hard to get an edge in terms of tactical positioning as the most important decisions will be made between politicians behind closed doors. It makes more sense to focus on investing in a mix of assets that is likely to be resilient in a wide range of scenarios.

No outcome seems overwhelmingly likely, but everyone can ensure their investments are not too exposed to the political uncertainty

Building on this, it helps to have exposure to growth-sensitive assets that are likely to behave differently from each other in different scenarios. UK equity prices tend to rise when sterling falls and vice versa, as they are valued off a stream of earnings sourced predominantly from overseas. UK commercial property is valued off a stream of sterling-denominated rents, so it is less impacted by changes in the exchange rate.

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We would also expect property prices to rise if the UK opts to stay closer to the EU, offsetting some of the drag sterling strength would create in the equity part of our  multi-asset funds.

Lastly, if you have a low appetite for risk, make sure your portfolio has a high allocation to sterling-based assets. That way you won’t be affected as much by swings in the exchange rate in either direction.

It is probably best to categorise UK equities as an overseas asset in this respect for the reason given above. Our lower risk multi-asset portfolios typically have at least 75 per cent of their exposure in sterling assets on this basis.

Brexit is a “known unknown” but it still has the power to move markets in a major way. No one can predict the final outcome with any degree of confidence, but everyone can take steps to ensure their investments are not too exposed to the political uncertainty one way or the other.

Trevor Greetham is head of multi-asset at Royal London Asset Management

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  1. “Preparing for the Brexit endgame”

    Get yourself an EU passport and emigrate.

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