Market Update – Brexit
28 June 2016
The EU referendum delivered a result that few expected, not least the leaders of the Leave campaign. Now the UK faces a potentially long, drawn out process of negotiating the UK’s actual separation from the EU. This includes agreeing new trade deals and interpretation of other existing treaties and laws.
Since the referendum result announcement on Friday, sterling is down roughly 7% and 10% against the Euro and USD respectively. This has placed sterling at a 30 year low to the US dollar. Meanwhile, the UK FTSE 250 has dropped roughly 12% and European stock markets (DAX and CAC40) are down about 10%. Shares of financials such as RBS, Barclays and Lloyds have been hit particularly hard and are down 20%. The FTSE100 is down 6% but is arguably less representative of UK companies given the amount of multinationals represented in the index.
While these are indeed very uncertain and possibly exciting times for investors, it’s still very early to say what the long-run effect will be on markets and portfolios. On one hand, times of high volatility can also present great opportunities to invest as the market succumbs to short term panic. On the other it should be remembered that an investor in risky assets (such as property, commodities and equity) should have a long-term time horizon before they invest, at a minimum of 5 years.
Another lesson from this referendum result is to avoid home bias and diversify. The UK comprises roughly only 10% of global equity market capitalisation and while the negative implications for the UK are large, they may be more muted for the global economy as a whole. Even considering the last two day’s of volatility, GBP investors will have made a positive return in GBP terms if they invested internationally (given sterling’s fall as mentioned above). For example, the Investment Association (IA) UK Equity Income sector has dropped 6% over the last month, meanwhile the IA Global Equity Income sector has returned a positive 4%.
Drawing these two lessons together, we’d like to remind our subscribers of the methodology we use to assess risk rated funds. Firstly, we forecast a fund’s volatility and risk using the expected 10 year volatility from Moody’s Wealth Scenario Generator (WSG) model. This ensures we accurately capture a full market cycle of behaviour and any price behaviour associated with booms, busts and market panics. Secondly, our optimised asset allocations ignore any home bias, and are diversified based upon 10 year forecasts of asset returns and volatility generated by the Moody’s WSG model. Quarterly reviews are made of all risk rated funds and approved by our Defaqto Investment Committee. The Moody’s WSG model has been backtested performance during previous market panics, and we have confidence the model is suitable for assessing risk rated funds for long-term performance - Brexit or not!