Preparing your portfolio for a no-deal Brexit

A no-deal Brexit now appears more likely than ever as the latest round of talks between the UK Government and the EU have failed to reach an agreement. Here’s what investors need to consider now. 

Boris Johnson set a deadline of 15 October to reach a trade agreement with the EU. This has now passed, and the Prime Minister has intimated that, although the UK Government remains open to a free trade deal, the country must now prepare for a no-deal Brexit.

So, what does this mean for investors and how should they react to this latest impasse?

There are a few important things to consider in the light of this new information, especially if you have exposure to UK and EU stocks.
 

Brexit already priced in?

Unlike the coronavirus crisis which set in fast and recovered equally quickly in investment market terms, Brexit is a longstanding issue for both UK and European markets. This means, relative to other markets such as globally focussed or US markets, the value of stocks in the UK and EU already reflects this uncertainty to an extent.

UK stocks in particular have been undervalued relative to their global peers for some time now. This potentially presents two options to investors:
 

1. If you are a holder of UK stocks, you might want to just keep holding. If the UK market is undervalued, then no matter the outcome of Brexit in the long run, it is possible that those stocks will start to perform better as undervaluation corrects itself.
2. If you aren’t a holder of UK stocks, but think that Brexit will ultimately not stop a rebound in valuations once the whole process is finally over, then now could be a good buying opportunity.

This is of course an optimistic viewpoint. If you are more sceptical about the UK’s outlook after Brexit, then you may wish to avoid UK markets completely until the picture is clearer.

This will clearly divide opinion, but options are available whatever your opinion, based on Square Mile fund selections for EQi. Funds such as Fidelity UK Smaller Companies or AXA Framlington UK Mid Cap are well positioned to take advantage of any upswing in UK equities.

Both funds invest heavily in medium and smaller companies that are the backbone of the UK economy and less reliant on foreign trade than constituents of the FTSE 100 might be.

Conversely if you’re looking to diversify away from the UK, then a global fund such as Fidelity – Index World makes for a good alternative.
 

Currency effect

As an investor considering the potential risks and rewards around Brexit, the issue of currency values cannot be ignored.

While this year has introduced some volatility for the US Dollar (the world’s number one reserve currency), against the pound it has rarely been in a much better position. There are two major consequences of this.

Firstly, buying assets that are priced in dollars, i.e. from outside the UK, will be more expensive for UK-based investors. Conversely, UK stocks, on top of Brexit-related price depression, will be cheaper to buy.

The second currency issue to consider is where a company or fund derives most of its income from. The FTSE 100 Index of companies, for instance, is mostly made up of UK-listed businesses that earn their incomes abroad. This is why, when the pound has lost value in recent years due to Brexit-related issues, the FTSE 100 has spiked in value.

These companies are importing earnings in foreign currency that could be worth more from one day to the next as the pound weakens. Of course, the opposite is true if the pound strengthens.

Whether or not the pound will regain some of the value it has lost is impossible to judge right now. Looking at the UK’s currency in the long run against the dollar, it’s hard not to get the impression that it has been on a downward trend for much longer than Brexit. The pound reached a decade-high of £1 = $1.71 in July 2014 and has been on a downhill trajectory ever since.

If you’re looking to hedge against a weaker pound, then Royal London UK Equity Income could be a good option. This fund invests in UK-listed shares but focuses its efforts on the FTSE 100, with 50% of the fund invested in the top index.

An alternative would be to look across the channel to a European-focused fund. A good option is Fidelity European fund which focuses on capital growth from large European companies.
 

What about beyond Brexit?

While these considerations are important, ultimately investors must look at the Brexit process in context. We are in the end-stages of the process and much of the value of it has been priced in by markets.

On top of this, investing should be thought of as a long-term pursuit to build wealth over time. While a no-deal Brexit may have short-term implications for the UK economy and investments, at this late stage it is unlikely to cause major disruption for too long in to the future.

No matter your feelings on the political process of Brexit, the world and investing markets, will ultimately move on from it. Perhaps a more important long-term consideration is how the UK might achieve its potential outside the EU, and whether it looks like the government might be able to pull off the promises made in 2016 by the Leave campaign.

Only time will tell.
 

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