With the date for the EU referendum set as 23rd June 2016, both the ‘stay’ and ‘leave’ campaigns are already raging in the media.
With strong arguments being raised on both sides, it can be difficult to understand the true impact of the vote. We look at the impact that Britain’s potential exit from the EU (known as Brexit) after the EU referendum could have on your investment.
There are many different polls quoted in the national media, showing wildly differing results. Here at Nutmeg, we’re working on the assumption that the UK will vote to stay in the EU. We currently think the probability of this is around 70%. However, we do have contingency plans in place should the chances of a UK exit begin to look more likely.
Nutmeg portfolios are in a strong position to weather short term market turbulence as an effect of the EU referendum.
Our exposure to the UK
Nutmeg portfolios currently hold far less exposure to UK assets than they normally would.
We recently sold all of our holdings in the FTSE 250, made up of mid-sized and small-sized UK equities. This is based on our view that smaller UK stocks are over-valued, but also that large stocks (the FTSE 100) will do better due to weak sterling helping profits. This is because, in the UK’s largest companies, 70% of their sales are overseas, but the stocks in the FTSE 250 are more UK-focused and would be hit if Brexit fears increase.
With our core view that the UK remains in the EU, in all but our high risk portfolios we hold a higher level of exposure to Japanese and European equities than normal. However we have hedged this exposure, meaning that we limit our currency risk.
This is because we anticipate significantly ramped-up monetary policy easing in Japan and the Euro-region; an action that would be expected to weaken those currencies.
Our US equity exposure is unhedged to provide benefits if the dollar appreciates. We think this is likely even without Brexit because commodity prices are still under intense pressure, which tends to lead to a strong dollar. We think there is a reasonable chance of a rate hike in the US by the end of the year, which should also strengthen the dollar.
As we don’t yet know the full global ramifications of a possible UK exit from the EU, it’s very difficult to protect portfolios against every eventuality, but Nutmeg portfolios are globally diversified and therefore are in good standing.
What might happen if we voted to leave?
If the UK did vote to leave in the EU referendum it would likely cause a large shock to UK growth in the short term. Business confidence would take a sharp fall, causing investment plans to be put on hold.
There would be a high level of uncertainty and we wouldn’t have clarity for months, if not years, after the vote and subsequent separation. There is also no guarantee that we would remain part of the European Economic Area (EEA), as per Norway’s current model, or even negotiate bilateral free trade agreements (as per Switzerland). Questions over trade regulations, and our ongoing relationship with the EU and EEA are likely to rumble on into the future.
Sterling would almost certainly take a big hit, perhaps falling to $1.20, or lower.
The direct impact on equities is likely to be high as investors dump risky assets. The relative impact to the FTSE 100 is still likely to be negative, although a weaker sterling would provide a boost to profits due to international trade.
The FTSE could also face the threat of large companies leaving the UK if trade agreements become too complex or expensive to implement. The future for gilts (UK government bonds) is also uncertain, but as investors move to quality and away from equities this may help gilts in the short to medium term.
What would be a more pressing concern is investors’ desire to sell off eurozone stocks. This would put increasing pressure on the two largest economies within the single currency – Germany and France. The question might be does the eurozone survive at all without the UK.
With the US elections around the corner, this is likely to add another layer of complexity into an already clouded global outlook.
It’s worth reinforcing again that we don’t expect the UK to leave the EU, however it’s important to fully consider all options, and we do have plans in place should that outcome begin to look more likely.
Risk warning: As with all investing, your capital is at risk. The value of your portfolio with Nutmeg can go down as well as up and you may get back less than you invest. Past or future performance indicators are not a reliable indicator of future performance.