On 23 June 2016, UK citizens are – for the first time in over 40 years – being asked to vote on whether we remain in the European Union (EU), or leave it.
Whilst politicians of every hue engage in an increasingly bitter argument over what the right decision should be, our in-house Investment Consulting team have put forward their views on what the short term impact of either outcome could be, in respect of various asset classes. This blog summarises those views for the most popular asset classes within self-invested pension arrangements; namely, cash, equities, property and gilts.
Impact of leaving the EU
We believe that Sterling will bear the brunt of the impact; both in the uncertainty preceding the June referendum and in the event that the UK decides to leave the EU. As the most liquid asset class, cash tends to move fastest in the response to news. Therefore, an immediate reaction to the 'shock' of a leave victory is likely to come through a fall in Sterling. There is a chance the Euro will also fall, so Sterling may not fall across all markets.
The most likely outcome, in our view, would be a fall in UK equities. Other equity markets may well follow suit. If we exit, it seems likely that there will be a transition to less risky assets while investors get comfortable with the new regime (and while the new regime is negotiated!), as well as a hold-off on further corporate investment and, therefore, a fall in more domestically-orientated stocks.
The experience of the Scottish referendum suggests that a slowdown in the property market may take place as the referendum approaches, although Sterling weakness could partially offset this. For those considering investing in property we would avoid doing so now, to circumvent ‘Brexit’-related volatility, but continue to believe that property should support reasonable investor returns.
Our view is that, whilst there may be some short-term volatility, a decision to leave the EU should not significantly change investors’ views on the ability of the UK government to service its debt; despite the expectation of a ratings downgrade. We’d expect some pausing of overseas purchases of gilts (£70 billion in 2015) and possibly a reversal; so there is a chance of a spike in yields. However, we see domestic demand for gilts, principally from UK pension schemes, remaining strong in the long-term – and therefore yields remaining low – even in the event we leave the EU.
"Although by no means intended to constitute a voting recommendation, the views of our Investment Committee above suggest that a ‘leave’ victory would have more of a negative short term impact on the asset classes under scrutiny than a successful outcome for the ‘remain’ camp would."
Impact of remaining in the EU
Sterling has fallen by 2.5% in 2016; the key question is if this is due to the Referendum and/or due to expectations on interest rate rises being pushed back to 2017 and beyond. If the former, and the UK votes to remain in the EU, there may well be a 'relief rally' in Sterling following the vote. Ultimately we’d expect some recovery in Sterling if there’s a decisive remain vote.
Again we need to ask ourselves, “how much is an exit already priced into equities?” Our view at the time of writing is very little if we compare performance to other regional equities – adjusting for the commodity bias. As a result, in the event we seek to remain within Europe, we’d expect little price reaction.
Despite fears surrounding the EU referendum and the Chancellor's ‘Buy to Let’ tax rises, property once again had a positive first quarter in 2016. The risk to UK property fundamentally lies in prime London residential property, which could see an exodus of existing tenants to Europe. This market has seen a 0.6% decline in the six months to 31 March 2016; the worst since 2009. Regardless of the outcome of the Referendum, however, we believe that UK property is valuable, not because the UK is a part of the EU, but because of the UK legal system, property rights and for fundamental demand and supply reasons.
Given our overriding view that yields are set to remain low for a considerable period of time, we do not expect a major reaction in the event of a remain vote. Short-dated yields may rise on the view that base rate rises are ‘back on the cards’ but overall, gilts in two to three years’ time would be expected to be higher than in the exit scenario.
The purpose of this Blog is to present a balanced, non-partisan, summary of what the short term impact of a ‘leave’ or ‘remain’ victory could be, on the most popular asset classes held within self-invested pension arrangements, (that is, cash, equities, property and gilts). Although by no means intended to constitute a voting recommendation, the views of our Investment Committee above suggest that a ‘leave’ victory would have more of a negative short term impact on the asset classes under scrutiny than a successful outcome for the ‘remain’ camp would. Indeed, it may be that a victory in itself would not necessarily be sufficient; the decisiveness of the victory may also play a part in what then transpires.