This article first appeared in the Telegraph
Whether Wednesday turns out to be High Noon or not, we no longer have the luxury of watching and waiting. With barely more than a month to go until Brexit Day, investors need to make sure they have a ‘no regrets’ portfolio. Whatever happens over the next few weeks, there are steps we should take to avoid ‘if only’.
Investing is about measuring risks and weighing up probabilities. The various possible outcomes next month could result in very different investment returns. Where possible, we need to make an assessment of the chance of each of these happening but, more importantly, we need to position our investments so that we can take any of them on the chin.
There are upside and downside risks to consider. We should not, for example, dismiss the possibility of a big relief rally if things turn out better than expected. How would that feel if we were too cautiously positioned? Possibly less concerning than if we are caught out by a negative shock. An opportunity loss is easier to handle psychologically than a real financial one.
The odds on the different scenarios are fluid at the moment, in particular following the recent defections from both major parties. These may not have changed the parliamentary arithmetic around the Prime Minister’s withdrawal deal because all 11 members of The Independent Group would have voted against it anyway. What has changed, however, are the odds on a general election this year, which have shortened considerably. Were the number of Conservative defectors to rise to 10, offsetting the DUP, the government would be reliant on Labour Leavers for Brexit business and would be unable to sustain a majority on other issues.
Even if the defectors don’t bring down the Government, the ERG might if Theresa May is forced into delaying exit by Yvette Cooper’s proposed extension of Article 50. Through a couple of different routes, therefore, the possibility of a Labour government must be greater now than it was a week ago.
On balance, there are more bad outcomes from a UK investor’s perspective than good ones so weighing the probabilities points to a cautious approach to investing in the domestic market. The first component of my seven-point Brexit-proofing plan, therefore, is ensuring that if your portfolio suffers, as many do, from home bias, you eliminate it.
The UK accounts for about 6% of the value of the global stock market. In many cases, however, it is a much bigger proportion of a UK investor’s portfolio. We have a tendency to prefer investing in familiar businesses, perhaps companies where we are customers or employees. That’s understandable but this is not the time to be over-exposed to the local market.
This is not the same thing as reducing exposure to the UK completely for a couple of good reasons. First, the widely-understood fact that the London market is a peculiarly international one. Perhaps 70% of the profits earned by FTSE 100 companies are made overseas. So, the second item on my list is to ensure that any UK exposure is biased towards large exporters and overseas earners. Many of these companies are additionally supported by high and sustainable dividends, frequently denominated in dollars which will obviously be helpful if sterling weakens in the coming weeks. The high dividends available in the UK market are a reflection of the poor relative performance of London shares - a decent income will provide ballast in stormy waters.
The flip side of ensuring that you are not over-exposed to the UK is making sure that your portfolio is well diversified around the world’s other markets. Not putting your eggs in one basket is a cliché for a reason. Broadly speaking, the further away from the UK a market is, the less concerned investors are about how Brexit turns out. There are plenty of other markets where non-Brexit related concerns have driven valuations down to attractive levels. China and Japan are good examples. Diversification is not just about geography either. A balance of fixed-income investments like bonds as well as property and commodities will smooth the ride too.
When it comes to sectors, the shortened odds of a Labour government this year have shone the spotlight on a number of industries. Re-nationalisation would not be easy or cheap but with political will it could be achievable, and in some cases it would be popular. Railways and utilities are obvious targets. Banks too might face unwelcome scrutiny. Defence contractors would be unlikely to enjoy spending at today’s level.
So, there are plenty of areas to consider avoiding. What might it make sense to top up on? Investors looking for safe havens invariably alight on gold, for good reason. Tracking its performance against global share indices, it tends to outperform significantly at times of heightened uncertainty. The oil shocks of the 1970s, the bursting of the dot.com bubble and the financial crisis all saw gold acting as a useful port in the storm. A small holding would not harm now.
The other classic safe haven is, of course, cash. This has the added virtue of allowing investors to take advantage of any volatility during the weeks ahead. There is no good argument for holding cash as a long-term investment at today’s lower-for-longer interest rates, but as an insurance policy and as dry powder in the case of market turbulence, it is hard to argue against it.
The final part of my Brexit strategy is to keep investing through the challenging weeks and months ahead. To the extent that we can automate our investment approach, dripping money into the market on auto-pilot rather than attempting to time the tops and bottoms, we should do so. High Noon is not the time of day to be making rational decisions.
The value of investments and the income from them can go down as well as up, so you may get back less than you invest. Investments in emerging markets can be more volatile than other more developed markets. This information is not a personal recommendation for any particular investment. If you are unsure about the suitability of an investment you should speak to an authorised financial adviser.