BREXIT AND INVESTMENTS
As the date for exiting the European Union approaches on the 29th of March 2019, this article examines what might happen with your investments and Brexit.
We cannot make predictions with investments and Brexit, but we can give you an idea of how you should financially prepare for it.
- Where are we with your investments and Brexit?
- Your investments and a No Deal Brexit
- What can you do to prepare your investments for Brexit?
- Are your investments ready for Brexit?
Where are we with your investments and Brexit?
There is still a great deal of uncertainty with Brexit:
- The final deal has not yet been agreed by Parliament
- The 29th of March is approaching, with unknown and potentially significant implications to the UK economy
- Many government plans are still vague and uncertain
Added to this, global stock markets suffered losses in 2018, partly (but not entirely) due to nervousness about Brexit. For example, the average UK shares unit trust lost 10.76% in 2018, while the average US shares unit trust lost 1.52% in 2018.
It is impossible to make accurate predictions regarding your investments and Brexit. However, without a resolution, a reasonable assumption will be to expect greater degree of volatility in investment markets.
Your investments and a No Deal Brexit
What might happen to your investments if the UK leaves the EU without a formal deal?
We have summarised some possible impacts on different investment sectors and types below.
We would expect that the value of the Pound Sterling versus other currencies to fall sharply, at least initially, in the event of a No Deal Brexit.
After the EU referendum (23rd June 2016), the value of the Pound fell sharply compared to other currencies, and has not recovered. The chart below shows the value of the Pound and the Euro, versus the US Dollar. The US Dollar is shown as a constant (in red), meaning the Pound (in blue) has lost significant value since the EU referendum.
Almost immediately after the EU referendum result the Pound fell by more than 10% compared to the US Dollar. It fell even further, and currently sits at around 15% lower than it was before the EU referendum. The fact that the Pound has not appreciated in relative value reflects that investors are generally negative about the prospects for the UK.
If the UK leaves the EU without a deal then the Pound is likely to suffer more weakness due to the continued uncertainty. This is likely to increase inflation in the UK.
Changes to the value of the Pound are likely to have an effect on your investments (see below).
There could be mixed results from UK shares. The likely fall in the Pound would have a negligible impact, although larger companies are more likely to be able to cope with a No Deal Brexit. Many larger UK companies have the benefit of trading overseas, or even in US Dollars, which could give them greater resilience. We would expect smaller and medium-sized companies to be hit harder, at least in the short term.
UK shares would be likely to fall initially after a No Deal Brexit, partly due to share sales driven by investor concerns. If we examine the results after the EU referendum, all UK shares fell sharply, but recovered quickly and grew steadily after that. The FTSE 100 index of larger UK companies fell by 5.62% at the worst point on the 27th of June 2016, while the FTSE 250 index of the “mid-sized” UK companies fell by 13.65% by the same date. Both indexes continued to rise over the following 2 years.
Don’t forget the impact of dividends. UK shares (particularly larger companies) tend to pay decent levels of dividends. This can have a levelling impact on any short-term fall in value.
Brexit would not have a direct impact on the returns of most overseas companies, but there could be a significant impact on the returns of UK investor holdings in overseas investments.
A fall in the value of the Pound could increase the value of overseas share holdings. For example, if we examine the return of the HSBC American Index fund for 2016 (the year of the EU referendum), the same fund gave these returns:
- 11.80% in US Dollars
- 33.35% in Pounds Sterling
The only difference between these returns was the currency the fund was bought in, and this was affected by the sharp fall in the value of the Pound in 2016. Therefore, if the Pound falls, and your fund invests overseas, any gains should be magnified. Feasibly, this could work the opposite way, if you believe that the Pound will rise following a successful Brexit.
If there is a No Deal Brexit then investors may look to invest in higher quality fixed interest investments, like UK Government gilts. Unfortunately, if inflation increases due to a fall in the Pound then yields tend to fall with gilts.
There could be pressures on some company debt such as some high yield corporate bonds, due to uncertainty in the general economy. If inflation was to increase, this could have a negative effect on fixed interest income (that is not index-linked).
Direct investments in property are difficult to predict, given that there are many influences on the market. Commercial property is more likely to be hit, particularly around London. Residential property prices may be affected by lower consumer confidence.
What can you do to prepare your investments for Brexit?
The reality is that we do not know what is likely to happen with your investments and Brexit. So what can you do to prepare for the unknown?
Sell into cash?
You may be tempted to take risk off the table by selling your investments and leaving your money in cash until the danger is over. Once the dust settles, you can calmly reinvest when the time is right.
You might think that you can time the investment markets something like this:
While this idea sounds sensible, this can easily go wrong. This can be illustrated by my conversation with Brian (not a client) just before the EU referendum. Brian handled his own investments in his pension plan. He was concerned that the UK might vote to leave the EU (he was correct), and that this would result in a fall in the value of his investments (he was right to a degree, but only initially).
My point to him was that trying to time the investment markets is dangerous, given that we do not know for sure what might happen. Despite this, Brian was adamant that he had to take the risk of the referendum off the table, so he sold his entire pension investments into cash. His plan was to reinvest when markets had recovered.
When the result of the EU referendum was announced, I am sure that Brian felt vindicated. The UK stock market was falling, but Brian’s investments were in cash, and did not fall. However a few days later the UK stock market recovered, and then continued to rise for another 2 years. Brian avoided the short-term fall in the value of his portfolio, but probably suffered a more damaging, and permanent lack of growth in his investments, because he probably waited to get back in to the stock market.
If Brian waited the following periods to reinvest in the UK stock market he would have missed out on the following growth:
- 6.13% after 1 month
- 9.19% after 2 months
- 10.59% after 3 months
The chart below shows the UK stock market growth in the 2 years after the EU referendum result.
Of course, none of this is guaranteed, and cannot be predicted to happen again. The point is that Brian’s short-term fear had a permanent negative impact on his long-term investment growth. Unless you have a specific short term need for access to cash, you are generally better off to wait and let markets do their work for you over time.
Read more about timing the investment markets in Our Investment Philosophy document.
Diversify your assets
At this point we do not know whether a deal will be agreed with the EU, and whether the outcome will be favourable. Any option could be taken, from a dramatic No Deal, to some sort of managed transition, or even the outside possibility of remaining in the EU.
If we admit that we cannot control the future, and investment markets, the only sensible approach is to properly diversify your investments. Most people we meet do not diversify their investments, and this could have significant implications with your investments and Brexit.
The outcome of the Brexit negotiations may have a positive or negative impact on various aspects of your investments, but we cannot predict the effect, or scope of this.
Diversification means picking different types of investments (shares, fixed interest, property, cash), and choosing different locations to invest (including outside of the UK). If you diversify properly, you will give yourself the best chance of managing the effects of Brexit.
Read more about diversifying your investments in Our Investment Philosophy document.
When do you need the money?
If you know when you need the money you have invested, you can be more relaxed about the effects on your investments after Brexit. Any investment will rise and fall in value, but in general, over time, we typically expect your investments to rise more often than they fall.
We examine this issue in Our Investment Philosophy document.
If you have a need to access your investments in the very short term, then you are at a greater risk of loss if Brexit does not go well for your investments. You should consider moving some or all of your money into safer assets, or cash.
If you do not need access to your investments for at least 5 years, then time is on your side. In general, the longer your invest, the less likely you are to suffer a loss to your original capital.
Providing investment income
If you use your investments for income you need to prepare carefully for the possible downsides of Brexit.
Imagine that your investments fall in value because of a No Deal Brexit. If you take an income from your investments this could affect you in 2 ways:
- Natural income
If you take the natural income yield from your investments, and those investments fall in value after Brexit, then your income will also reduce. Consider what you would need to do to replace the lost income, or how you would cut back on lifestyle costs.
- Capital withdrawals
If you take fixed levels of capital withdrawals from your investments, and the value falls after Brexit, then this could mean your investment capital is eroded faster than you might want. The efecct of fixed withdrawals is greater when your investment value is falling. You may need to reduce the value of your withdrawals to preserve the length of time you may access your withdrawals.
One solution is to set up an “income cashflow reserve” account for your income. This is a kind of a buffer account, that allows you to keep taking withdrawals for income, without affecting your underlying investments. Your buffer account might work like this:
How to set up your buffer account:
- Work out how much regular income you need from your investments
- Put aside 2 years worth into your buffer account
- Pay your regular income from the buffer account into your current account
- Leave your investments to fluctuate (provided they are properly diversified)
- Top up the buffer account at regular review points, or when seems appropriate
Are your investments ready for Brexit?
If you are concerned about your investments and Brexit, we recommend the following action:
- Decide when you might need access to your investments
- Make sure your investments are properly diversified for the risk taken and when you might need access
- Examine what might happen to your income if your investments fall in value
- Check you have access to enough cash to ride out any short-term volatility
- Don’t make any snap decisions – investing is a long-term strategy, and values always fluctuate
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