Brexit and the power of diversification

18/09/2019

For British investors, the past few years have ably demonstrated the risks that can accompany focusing your investments too narrowly.

Glossary

For explanations of the investment terms used throughout this article.

View the glossary

Since the referendum vote to leave the European Union in June 2016, UK company shares have underperformed global stockmarkets overall, and the value of the pound has fallen considerably. Most UK-centric approaches to investing have therefore disappointed.

By ensuring that your investments are allocated in a more balanced way across assets around the world, you can avoid your savings being hostage to the fortunes of any one market, even that of the UK.

Decoupling your fortunes from sterling

As the pound plunged below US$1.20 early this September – its lowest valuation in US dollars in 35 years – it is worth remembering that £1 bought $1.50 as recently as 2015. Just over a decade ago, before the financial crisis, £1 could be exchanged for $2.

If you’ve been abroad recently (almost anywhere other than Argentina or Turkey, perhaps), you will be keenly aware of sterling’s weakness. Holidays aside, the devaluation means that assets denominated in pounds will have fallen in relative value, unless their price (in pounds) has risen correspondingly.

Keeping your wealth tied up in any single currency can therefore clearly be to your detriment. You can insulate the real value of your portfolio from any further weakening in sterling by ensuring that your assets are denominated across a range of currencies.

To illustrate, let’s take a simplified example of a portfolio comprised half of dollar-denominated assets and half of pound-denominated assets. While pound assets have fallen in relative value since 2016, all other things being equal, dollar assets have risen. The overall value of this blended portfolio, in real terms, will have therefore remained relatively unaffected by currency market fluctuations, as the falling pound and stronger dollar cancel each other out.

Of course, should the value of the pound recover and soar as it did during the mid-2000s, investors with sterling-dominant portfolios would profit. Yet gambling on future currency values is arguably imprudent at any time, especially since it is cheap and easy to gain diversification across currencies.

Spreading your risks geographically

Diversification by currency is important, but on its own will not insulate a portfolio from market volatility. Another key and related ingredient is to ensure your investments are spread across different types of assets across a range of countries and regions.

After all, the fate of the global economy will not be determined by Brexit to the same extent as the UK economy and its companies will be. This is especially true of economies beyond Europe, for whom the effects of Brexit will be especially peripheral.

Indeed, pessimism about the potential ramifications of a ‘no-deal’ Brexit, combined with sluggish UK economic growth, have dampened the share price performance of domestically focused UK companies. In the 12 months to the end of August 2019, the more UK-centric FTSE 250 Index delivered negative returns of -3.4%, versus a positive return of 1.5% from the FTSE 100, whose larger constituents generate most of their profits overseas.

Meanwhile, over the same 12-month period, global stockmarkets (excluding the UK) delivered total returns of 8.0%, in sterling terms, as measured by the MSCI ACWI ex UK Index. Past performance is obviously no guarantee of future returns, but this disparity illustrates how the risk of disappointment can be reduced by investing more widely.

Pursuing effective diversification

Achieving effective diversification across and within different types of assets, regions and currencies can be challenging. Individual funds often focus on one asset class, and sometimes one country or region, and therefore may only offer limited diversification on their own.

By investing across a number of funds that cover a breadth of underlying assets, you could aim to create a more effectively diversified portfolio. There are also multi-asset funds that hold a blend of different assets in one single investment.

Remember, each fund has its own objective and approach towards risk and return. It is important that any investments are suitable for your goals and circumstances. If you are unsure about the suitability of your investment, please speak to your financial adviser.

While it cannot guarantee against losses, diversifying your portfolio effectively – holding the right blend of assets to navigate the volatility of markets – will probably help you achieve your long-term financial goals at the minimum risk.

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.