Let's talk about politics

We normally avoid discussing politics, but the current Brexit situation is an ideal opportunity to illustrate the benefits of long-term thinking. 

Broken egg showing UK and EU flags

Whichever way you voted, it is hard not to be dismayed by the shambles that is Brexit, concocted by all sides. In the increasingly likely event that the recent deal agreed with the EU gets voted down in Parliament on 11th December, there is a material chance that the government could fall. One or both of these events would come with great uncertainty.

There are, we believe, three key investment risks relating to Brexit. Here's how sensible portfolio structures can mitigate them.

The three risks

Risk 1: Greater volatility in the UK and possibly other equity markets

In the event of Parliament voting down the deal, it is certainly possible that the UK equity market could suffer a market fall as it tries to come to terms with what this means for the UK economy and the impact on the wider global economy.  A collapse of the Conservative government and a Labour victory would add further uncertainty.

Risk 2: A fall in Sterling against other currencies

In 2016, after the referendum, Sterling fell against the major currencies including the US dollar and the Euro.  There is certainly a risk that Sterling could fall further if Parliament votes against the deal.  

Risk 3: A rise in UK bond yields (and thus a fall in bond prices)

The economic impact of the deal failing and/or a high-spending socialist government could put pressure on the cost of borrowing, with investors in bonds issued by the UK Government (and UK corporations) demanding higher yields on these bonds in compensation for the greater perceived risks. Bond yield rises mean bond price falls, which will take time to recoup through the higher yields.

The mitigants of an evidence-based portfolio

Mitigant 1: Global diversification of equity exposure

Although it is the World’s sixth largest economy (depending on how you measure it), the UK produces only 3% to 4% of global GDP, and its equity market is around 6% of global market capitalisation.  Well-structured portfolios hold diversified exposure to many markets and companies.  Changing your mix between bonds and equities would be ill-advised.  Timing when to get in and out of markets is notoriously difficult. Provided you do not need the money today, you should hold your nerve and stick with your strategy.     

Mitigant 2: Owning non-Sterling currencies in the growth assets

In the event that Sterling is hit hard, it is worth remembering that the overseas equities that you own come with the currency exposure linked to those assets.  Remember too that a fall in Sterling has a positive effect on non-UK assets that are unhedged.  The bond element of your portfolio should generally be hedged to avoid mixing the higher volatility of currency movements with the lower volatility of shorter-dated bonds.

Mitigant 3: Owning short-dated, high quality and globally diversified bonds

Any bonds you own should be predominantly high quality to act as a strong defensive position against falls in equity markets.  Avoiding over-exposure to lower quality (e.g. high yield, sub-investment grade) bonds makes sense as they tend to act more like equities at times of economic and equity market crisis. 

Even if you cannot avoid watching, hearing or reading the news, it is important to keep things in perspective.  The UK is a strong economy with a strong democracy.  It will survive Brexit, whatever the short-term consequences that we will have to bear, and so will your portfolio.  Keeping faith with both global capitalism and the structure of your portfolio and holding your nerve, accompanied by periodic rebalancing is key.  Lean on your adviser if you need support.

‘This too shall pass’ as the investment legend Jack Bogle likes to say.

For more on this subject, download volume 46 of our Acuity newsletter: Politics and Portfolios'.

RT @ScottMonty: Careful! The Queen can move in any direction. https://t.co/LFmzwCwqKq