Brexit Implementation Guide

Capital at risk. The value of investments and the income from them can fall as well as rise and are not guaranteed. You may not get back the amount originally invested.

Key points

  • With Brexit uncertainty continuing to weigh on the UK economy and showing no signs of abating, we consider the potential impact for investors.
  • In the second quarter of 2019, the UK economy contracted for the first time in seven years, while surveys point to ongoing contraction in the manufacturing sector.
  • Investors have shied away from UK stocks and bonds in recent months, amid heightened political uncertainty.

The lack of clarity around Brexit has weighed on the UK economy since the 2016 referendum, when the public voted to leave the European Union (EU). This uncertainty has escalated in recent months following the resignation of former Prime Minister Theresa May, which triggered a leadership contest in the Conservative party and further uncertainty around the government’s approach to Brexit. Against this backdrop, we consider how investors may wish to position their portfolios.

The economic impact

Growth has been slowing in the UK, with preliminary gross domestic product (GDP) figures pointing to a -0.2% contraction in the second quarter of this year – the first quarterly drop in seven years. Data is also showing a sustained contraction in the manufacturing sector, and the UK’s dominant services sector is stagnating. Our analysis suggests that UK growth rates may even fall further than economists currently predict, as a result of muted business investment and a global slowdown in the industrial sector.

Bright spots do remain, however: UK wage levels have been rising at the fastest pace in more than a decade, while unemployment has fallen to 3.9% – its lowest level since the 1970s*. Inflation is close to the Bank of England’s (BoE) 2% target rate and a lack of inflationary pressures, alongside an uncertain Brexit outcome, means that the BoE may refrain from raising interest rates any time soon. Brexit uncertainty has largely played out through sterling, which has proved to be increasingly volatile. Traditionally, the currencies of emerging market (EM) countries tend to be more volatile than those of developed market (DM) countries, but over the past year, the pound has proved more volatile than a basket of EM currencies (see chart 1).

Chart 1: 30-day volatility of GBP/USD vs. 30-day volatility of a basket of EM currencies

Chart 1: 30-day volatility of GBP/USD vs. 30-day volatility of a basket of EM currencies

Source: BlackRock and Bloomberg, 14 August 2019
*Source: Office of National Statistics, August 2019

Sentiment towards UK stocks and bonds

Global investors have shied away from UK stocks since the first quarter of this year, especially in the run up to Boris Johnson’s appointment as Prime Minister. In the first quarter of this year – before the initial 29 March Brexit deadline – investors globally invested around USD 1.9 billion into exchange-traded products (ETPs) that track UK stocks. This was the largest quarterly inflow into ETPs tracking UK stocks. Subsequent quarters have registered outflows of $252m and $106m respectively from UK stocks ETPs. In contrast, investors globally have invested around USD 500 million each quarter this year into exchange-traded products (ETPs) that track UK bonds*.

Among UK clients, we’ve seen quite a high allocation to non-UK stocks (14% in US stocks and 8% in EM stocks), which leaves portfolios exposed to potential volatility in currencies. In fact, our analysis suggests that currency risk is the second most prevalent risk within the portfolios of our UK clients.

Potential Brexit outcomes and their impact for investors

Below, we set out four scenarios that are still viable outcomes for Brexit. These scenarios are not mutually exclusive.

  1.  A further extension of Article 50 (potential upside as it is an extension of the status quo)
  2.  A form of the Withdrawal Agreement passes in Parliament (potential upside as it is an orderly exit)
  3.  No-deal exit (potential downside as the outlook is extremely uncertain)
  4.  General election (potential downside as this creates more uncertainty)

In the following table, we have classified each scenario as either ‘upside’ or ‘downside’, based on our assessment of whether they could trigger a positive or negative reaction in stock and bond prices from the perspective of a sterling or non-sterling investor (i.e. UK-based or non-UK-based).

Chart 2: Upside (Scenarios 1, 2) and Downside (Scenarios 3, 4)

ALL FIGURES IN USD.

*Source: BlackRock and Markit, 16 August 2019

Reference to individual investments mentioned in this communication is for illustrative purposes only and should not be construed as investment advice or investment recommendation.

Any opinions and/or forecasts represent an assessment of the market environment at a specific time and is not intended to be a forecast of future events or a guarantee of future results. There is no guarantee that any forecasts made will come to pass.

Wei Li
iShares EMEA Head of Investment Strategy

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