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Brexit Risk Reduction

As we get closer to the EU referendum, markets are getting more and more nervous.

A month ago it looked quite likely the referendum would result in a “remain” vote. However, recent opinion polls have changed direction and now many polls put the leave camp ahead.

However, we all know the flaws in opinion polls after last year’s election and betting markets are still telling a different story. For example, Predictwise.com is currently giving a 61% chance of the result being to remain in the EU. However, even that is well down on the over 80% chance implied by betting markets a month ago.

We have generally taken a somewhat cautious stance in the run up to the referendum with slightly less in equity than usual. We have also reduced UK commercial property which is already showing signs of vulnerability to reduced investment flows.

However, given the increased chance of a win for the “leave” camp and the potential impact this could have on many asset classes, we have decided to take an even more cautious stance in the short term.

We have decided to make small reductions in equity, property and fixed interest, increasing cash holdings. In our balanced model portfolio we have reduced each of the asset classes by approximately 3%. Other models and bespoke portfolios will have had slightly different reductions.

Should the result be for the UK to remain in the EU, then we think markets may recover. We believe this is the most likely result but we also feel we should hedge our bets. Most clients have told us that they would rather give up some potential gains in the short term, in return for further protection should markets slide.

In the event of a “remain” vote we are likely to reinvest some or all of this cash. Of course markets could have moved sharply upwards relative to when we sold but we believe the overall impact would be limited. For example, a fairly extreme but possible scenario could look something like the following:

  • Equity markets recover by 5%
  • Property funds reprice back up by 5% as investment flows recover
  • Fixed interest funds go up by 2%

With a reduction of 3% from each asset class, the total impact of this scenario on a portfolio would be lost returns of 0.36%. We believe it is unlikely we would see such a combination of events and so even if markets move up whilst we hold additional cash, most likely the impact would be less than in the above scenario.

We always emphasize that our role is not just to chase returns but, where appropriate, take steps to protect capital. It is always a fine balancing act between risk and potential return, but right now we think it is wise to focus on reducing risk.

We will keep you update with future developments but should you have any queries in the meantime, please get in touch with your usual Equilibrium contact.