Listen to this article
Rising uncertainty over whether the UK will leave the EU is putting your wealth at risk. With little over a month to go until Britons decides whether to back a Brexit or remain in the union, the polls are close, sterling has taken a pummelling and the UK economy appears to have paused for breath.
As we enter the closing weeks of the campaign, more adventurous investors are seeking to take advantage of the uncertainty by placing strategic bets on what the markets will do in the event that the UK stays, or leaves.
Investors in the the FTSE 100 have been largely sheltered since prime minister David Cameron announced Britain’s EU referendum in February, thanks to the large proportion of companies listed in the leading share index who make profits outside of the UK.
Far from seeing this as an opportunity to bail out, many investors who are confident that Britain will vote to remain in the EU see this as a short-term buying opportunity.
If the referendum result on June 24 is “remain”, then the hope is that the UK will bounce back to business as usual, with Brexit-sensitive shares and assets rallying in relief.
However, many economists fear that a vote to leave the union could cause at least two years of volatility in the value of your investment portfolio and in the wider UK and European economy.
Brexit would increase the chances of the British pound weakening against the dollar and the euro by as much as 20 per cent, according to forecasts by The National Institute of Economic and Social Research. That would not only increase Brits’ cost of travel and doing business abroad, but also make it costlier for British investors to buy European or US shares or bonds in their home currency.
And if you are hoping for a new job or a promotion, your employer could be one of the many that has put hiring and expansion plans on ice until Britain’s economic future becomes clearer.
George Osborne, the chancellor, this week warned of “tens of thousands” of potential job losses in the financial services industry if Britain votes to leave.
Unsure of the result? You may be tempted to think like a professional investor, and carry out what the fund managers and bankers refer to as “hedging” and rejig your portfolio to minimise the risks of both outcomes.
But for those prepared to adopt a more adventurous trading strategy, who better than FT Money’s Adventurous Investor columnist David Stevenson to talk you through the options, as he assesses opportunities for picking up a few bargains.
OPTION 1: Hedge your risks
So what should investors do about all this Brexit uncertainty? Many observers reckon that investors should simply batten down the hatches, ignore the expected market volatility and simply make sure they are as globally diversified in their investments as possible, writes David Stevenson. This long-term view is especially sceptical of one tactic, namely to insure your portfolio of investments against risk by in effect insuring the potential downside risk — called hedging.
London Business School’s Elroy Dimson and Paul Marsh have looked at the benefits (and costs) of hedging a portfolio of long-term investments. They found some benefits in the short term in insuring against market swings, but over time, the costs outweigh the benefits (insurance always comes at a cost in terms of fees, for instance).
Nevertheless, hedging against market volatility could work for investors with shorter time horizons. For adventurous types, the best hedge is to make a profit from a big contrary move that impacts your portfolio. The simplest strategy might be to invest in mainstream ETFs, or investment trusts and unit trusts offering what’s called a currency hedging “overlay”. Many active managers in international funds already build this into their strategy — especially in the much more volatile markets of Asia, for instance — but you can also buy mainstream ETF trackers from the likes of iShares and Lyxor for major markets that are either monthly or daily hedged.
Here’s one typical example from the biggest ETF issuer iShares. If you want to carry on investing in eurozone equities but don’t want the risk around sterling falling (or increasing, for that matter) you could track the MSCI EMU index — a basket of large-cap eurozone blue-chips. It’s possible to do this via an ETF with the ticker EMUU. Its total expense ratio (TER) is 0.38 per cent while the non-hedged version (ticker CEU) has a TER of 0.33 per cent, implying that the hedge costs 5 basis points a year.
It’s important to understand with a hedging strategy that volatility either way is removed — so you might protect yourself on the downside, but you also miss out if the foreign exchange rate moves in a more favourable way.
OPTION 2: Gamble
Alternatively, investors may be tempted to try to profit from the possible turbulence and mayhem.
This involves a much more adventurous take on the markets and requires you to be opportunistic and tactical — you absolutely need to protect against the downside of making the wrong call on inherently unknowable outcomes. In simple terms, keep any “speculation” or “bets” to a minimum and constantly watch your position, and be ready to use stop-loss positions to cut your losses if the market moves the wrong way.
You also need to understand the product you are buying. Spread betting can be simple and cost effective but losses can spiral out of control quickly. Many exchange traded products — especially short and leveraged trackers — can be purchased through a stockbroker, but they come with their own costs and they usually track daily volatility of markets which means that you could lose out on a big trend if the market moves violently up and down in a short period of time.
OPTION 3: Bet on Brexit
For those still tempted to take a punt on the markets, let’s look first at a vote for Brexit. Talking to traders and hedge funds, the first big call would be to short sterling against the dollar. The logic here is simple. US investors might panic about holding sterling and local assets and sell the pound.
I suspect markets will initially over react. A pound currently buys around $1.45. It could fall abruptly after a “leave” vote, so that one unit of sterling might purchase only $1.30.
I wouldn’t extend this logic to the currency pair between sterling and the euro, however. A Brexit could be perceived as being bad news not just for the UK but also the eurozone, possibly even accelerating the collapse of the union. In this eventuality, I suspect there’s a decent possibility that eurozone equities — tracked by something like the DJ Euro Stoxx 50 index — could also fall sharply, with small-caps hit especially hard.
Sticking with the equities theme, most traders are likely to take risk off the table, and sell UK equities (the FTSE 250 index is the most vulnerable) with certain sectors hit very badly — anything in the consumer discretionary spending area and housebuilding could suffer as investors worry about consumers postponing spending decisions.
I’d argue that housebuilders are already looking a tad vulnerable in valuation terms, but the big travel giants — Tui and Thomas Cook — might be hit harder in the short term. Paradoxically, longer term investors might view this sell-off as a great buying opportunity as I suspect that disruption is likely to be short term and the sell-off — if it comes — may be too aggressive.
In the medium term, I’d be much more cautious about the UK financial services sector. A recent Open Europe report (a body that is broadly Eurosceptic, but currently neutral over the vote) looked at how different sectors of the UK economy would be affected. They reckoned that car manufacturers and engineers would be at a high risk of disruption but that the chances of regaining EU access would also be high. For financial services, the risk of disruption was high but the chances of regaining access low. That’s potentially bad news for those financial services firms with big European operations.
One last counterintuitive trade — UK government bonds or gilts. Foreign investors might panic at first, selling off these gilts but the Bank of England is unlikely to sit idly by and not intervene. It could start aggressively buying gilts, pushing prices up as foreign investors sell.
OPTION 4: Bet on Remain
And what might happen if the UK votes to stay? In most cases we can expect a reverse of the above, with a relief rally in many key asset classes. Sterling could strengthen markedly with the cable rate between sterling and the pound possibly pushing past $1.50 and maybe even moving within spitting distance of $1.55.
The dollar is already looking vulnerable as uncertainty about the pace and number of rate rises in the US grows, so a resurgent sterling could add to the turmoil. It’s also worth noting that since 2010, sterling has rarely traded much below $1.50.
Investors might also react enthusiastically about risky assets such as UK equities — with the FTSE 250 and consumer focused sectors the most likely to benefit (as well as housebuilders and financial services firms). Over in the eurozone we might also see a sharp rally in small-cap equities as investors stop worrying — for now at least — about the break-up of the eurozone. And maybe we will see a small gilts sell off.
One final note — the most difficult scenario to plan for in investment terms is the “leave, but then re-enter” scenario, imagined by some politicians including Boris Johnson. This would involve the UK voting to leave, but then renegotiating a new deal to re-enter the EU at some later date after umpteen concessions are agreed. This presents numerous obstacles — not least prolonged uncertainty spanning many years. If this suddenly starts to seem like a distinct possibility the best idea for investors might be to accelerate their international diversification and batten down the hatches.
UK’s EU Referendum: How people would vote
For a more detailed summary of opinion polling visit the FT’s Brexit poll tracker page
Are markets betting on a Brexit?
Many people in the financial markets are seriously betting on Brexit — but should private investors? Here, we lay out the best of the data for you to assess how markets have reacted so far, and what could happen after the vote on June 23.
The Financial Times’ Brexit poll tracker, which summarises the main national polls, gives the Remain camp some comfort. It currently shows an average estimate of 46 per cent wanting to remain in the EU, while 43 per cent wish to leave.
A Brexit would cast a pall of uncertainty over UK companies and stock markets, not to mention UK exporters. The EU is a single market, meaning British companies from drugmakers to fund managers can sell their wares across member nations, just as if they were selling domestically. EU customers do not have to pay tariffs or import charges when buying British goods. After a Brexit, no one is quite sure what sort of trade relationship home businesses would have with EU buyers.
Torsten Müller-Ötvös, chief executive of BMW-owned Rolls-Royce, said in a letter to staff in March that in the event of Brexit, “tariff barriers would mean higher costs and higher prices and we cannot assume that the UK would be granted free trade with Europe from outside the EU”.
The EU also has agreements allowing free trade with countries such as Norway, Switzerland, South Africa and South Korea. Britain benefits from being part of the EU-wide partnership with these countries. If Brexit occurs, the UK would need to strike its own deals.
UBS economist Reinhard Cluse argues that an “out” vote would prompt markets “to price in confrontational negotiations between the EU and the UK”, over Britons’ continued rights and trade relationships in Europe.
More volatility in UK equities is expected, at least compared to US stocks. The Vix Index in the US, which is dubbed Wall Street’s fear gauge because it measures how much stock market turbulence traders expect in the next 30 days, is signalling calm, having declined 22 per cent in the four months to May 5.
The UK version of this fear index has headed the other way, rising 9 per cent to its current level of 18.98 in the same period, although this is not far above its average over the past five years.
As the Brexit debate moves into its final phase, recent history suggests market turbulence will increase, although stocks could also rally hard if the UK votes to stay in Europe.
Last July 5, Greek citizens voted against accepting continued austerity measures from the country’s international lenders, putting the debt-laden country at risk of being forced to leave the EU. Crisis was averted by Athens accepting another emergency bailout in return for reform pledges, but in the run-up to the Greek vote, markets quaked at the prospect of a result that could change the status quo.
The Euro Stoxx index of top European shares fell by almost 8 per cent between June 1 and July 8 last year, before bouncing back sharply.
UBS’s Mr Cluse believes the pound would be by far the most vulnerable asset to a Brexit. The Bank of England, which is putting contingency plans in place for a run on sterling, agrees with him.
At the beginning of this year one pound would buy you €1.36. By May 5, that rate had fallen to €1.26.
The sterling rate against the dollar (known as the ”cable rate”) has been a little less volatile — and much more influenced by other factors including the US Federal Reserve’s statements on rates — but it fell from $1.47 dollars to the pound at the beginning of the year to a low of $1.38 at the end of February.
Sterling is not the only asset being targeted by traders who feel negative towards the UK economy. Wisdom Tree, a company that sells exchange-traded products allowing clients to bet on whether UK stock markets are going up or down in the future, has noticed a marked rise in punters wishing to “short” the UK FTSE 100 and FTSE 250 indices, which is a way of gambling that they are set to fall.
And all this uncertainty about Brexit is, of course, affecting real businesses, and not just markets and assets. Data compiler Markit’s purchasing managers’ index for the UK’s services sector, which dominates economic growth and comprises businesses from hotels to broadband providers fell to its lowest in three years in April. Markit blamed uncertainty over Brexit for much of the slowdown. Just how much of this can be put down to referendum nerves will only really be known after June 24 when the results are revealed.