Brexit and Sterling

02/01/2019

The Treasury is planning to mint a commemorative 50p coin in the Spring, to mark the UK's departure from the European Union.

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The coin will reportedly feature the date - 29 March 2019 – and, on the reverse, the phrase "Friendship with all nations".

But for investors a more pertinent question is – what will happen to the UK currency, and assets denominated in sterling, after Brexit?

Taking a pounding

On the day after the referendum result, back in June 2016, the pound fell to its lowest level versus the US dollar since 1985. Sterling slowly recovered some of its lost strength through the second half of 2017 and the first half of 2018, before sinking back towards its post-referendum low in recent months.

So, where could we be heading in the months ahead? Ben Lord, manager of the M&G UK Inflation Linked Corporate Bond Fund, suggests three possible scenarios:

“If we do stare down the risks of a no-deal, or a harder Brexit deal, you’re going to get a weaker pound, and inflation expectations are going to pick up on the back of the weakness of the pound”, he says.

In the event that Brexit doesn’t happen and the UK remains in the EU, however that might come about, Ben says “the pound would rally, probably straight back to pre-referendum levels”.

Were there to be a general election in the UK, “you have the chance of a Jeremy Corbyn-led Labour government. That really would be the end of austerity and the pound would move sharply lower”, Ben says.

Looking at the bigger picture, Jim Leaviss, M&G’s Head of Retail Fixed Interest, makes the point that a lot of ‘bad news’ is already factored in to sterling’s value. “The pound is already looking undervalued versus most global currencies”, he says. “The extent to which negative expectations are already baked into asset prices today does at least limit the potential downside for investors”.

Don’t put all your eggs in one currency basket

Given the challenges in predicting the outcome of the tortuous Brexit process, how can UK investors mitigate the currency risk?

As the devaluation of the pound illustrates, an investment portfolio comprised of assets valued in a single currency can be subject to greater price volatility than one spread across different currencies.

Let’s assume a model investment portfolio with half the assets valued in US dollars, the other half in pounds. While the sterling assets would have fallen in relative value with the pound’s depreciation, US dollar assets would have risen in relative terms. The overall value of the portfolio, in real terms, would have balanced out to some extent.

Stay invested, but be discriminating

One of the most common mistakes investors make is to conflate volatility with risk, or the chance of permanent financial loss. Investors often have a tendency to react to the news cycle, rather than focusing on whether moving events really impact the fundamental value of assets they hold.

The prospects of some British companies, for example, might be only marginally affected by Brexit, but their share prices might have suffered with the broader sell-off across the UK stock market.

Instead of trying to predict what Brexit will look like, it may be more profitable for long-term investors to look for opportunities where markets are either overly or insufficiently worried about what its implications might be.

Important information

The value of investments and the income from them will fluctuate. This will cause the fund price to fall as well as rise. There is no guarantee the fund objective will be achieved and you may not get back the original amount you invested.

The views expressed in this document should not be taken as a recommendation, advice or forecast.

Please refer to the glossary for an explanation of the investment terms used throughout this section.