How to Brexit-proof your portfolio

Whether you believe Brexit will prove a blessing or a curse for the British economy, or that the next General Election is years away or imminent, how can you insulate your portfolio from market uncertainty?

Stock markets dislike uncertainty. Institutional and individual investors alike resent the possibility that rational decisions, based on financial facts and figures, might be overturned by political changes affecting international trade, taxation and/or the occupants of Downing Street.
 
As a result, doubts about the immediate future are being discounted in share prices and fund valuations. So, what can we do to Brexit-proof our portfolios or shelter our savings from potential political events? The simple answer is to remember what is sometimes called the first rule of investment; “spread risk”.
 
Diversification to diminish our exposure to the danger of setbacks or failure at any one company or country is a tried-and-tested way to cope with the uncertainty inherent in life, politics and the stock market. In plain English, it boils down to the common sense advice not to have too many eggs in one basket.
 
The simple answer is to remember what is sometimes called the first rule of investment: spread risk.
This fundamental principle is put into practice by pooled funds - such as unit and investment trusts, open-ended investment companies (OEICs) and exchange traded funds (ETFs) – which can all provide convenient and cost-effective ways to spread individual investors’ money over dozens of different underlying assets in a bid to maximise returns and manage risks.
 
For example, diversification is enforced by statute in unit trusts because these pooled funds are not allowed to invest more than 10% of their assets in any one company. As current controversies remind us, country risks – or issues specific to one sovereign jurisdiction – are another potential problem for investors.
 
One solution is to consider, in conjunction with your professional adviser, some exposure to international funds, such as unit and investment trusts or OEICs and ETFs authorised and regulated in London but with assets allocated overseas.
 
These international funds can bring a world of opportunity within reach, without giving up any of the protection provided for investors by the United Kingdom’s statutory regulation of financial services.

MSCI World Index

61%

Proportion of shares that are American

9%

Proportion of shares that are Japanese

6%

Proportion of shares that are from UK

Investing internationally can seem counterintuitive because it is natural to favour the familiar and to shun the strange or exotic when allocating hard-earned savings. For example, it can be comforting to recognise brands or company names when considering the top-10 holdings that most pooled funds publish – and unsettling to find they are all foreign.
 
This explains the tendency to invest exclusively or too much in the country where you live. So it may be instructive to consider the UK’s position in the global economy.
 
The MSCI World Index – formerly Morgan Stanley Capital International – is probably the most widely-recognised benchmark of developed economies’ stock markets. While it is no surprise to find American shares comprise 61% of the MSCI or that Japan ranks second with 9%, it is interesting to note that the UK comes third with just 6% of the total.
 
France follows up with 4%, Canada with 3% and “Other” accounts for 17%. Of course, this benchmark is only one measure of global stock markets and critics could argue that China – now the world’s second-largest economy on some measures – ought to have a higher and more prominent weighting than being bundled under “Other”.
 
Closer to home, the London Stock Exchange reports that the companies that comprise the FTSE 100 index generate more than 70% of their revenues overseas.
 
So fans of the FTSE can argue that funds following this benchmark deliver more international exposure than you might expect.
70%
Proportion of revenues by by companies that comprise the FTSE 100 generated overseas
Sadly, fund and share prices are only two of the factors that should be considered by investors keen to minimise risk and maximise rewards; currency fluctuations are another factor and FTSE shares are predominantly denominated in sterling.
 
So any investor who travels overseas on business or pleasure who wishes to preserve the real value or purchasing power of their money should consider some exposure to funds holding assets that are denominated in more than one currency; for example, bonds and shares traded in dollars, euros, Swiss francs and Japanese yen.
 
Another reason is the diversified and rising income that overseas companies and funds can deliver. At first glance, UK dividends seem highly satisfactory after delivering a record total of £94bn last year. That was 74% more income than shareholders in British companies received in 2010, easily beating inflation on the high street.
 
But investors who backed international shares and funds saw their income rise twice as fast over the same period. For example, American dividends advanced by an average of 148% while Japanese payouts jumped by 144% - and Asia ex-Japan did even better, soaring by 162%, according to calculations by a major fund manager (Janus Henderson).
 
While the past is not necessarily a guide to the future, it is interesting to see what has happened to share prices on the world’s biggest stock markets since Britain voted to leave the European Union on 23 June 2016.
 
At the time of writing (July 10), both the best-known benchmarks of American and Japanese shares – the Dow Jones and Nikkei indices – have risen by about a third (34% and 33% respectively) while the FTSE 100 has risen by less than half as much (15%) since the Brexit vote.

Rise in markets since Brexit vote

34%

Dow Jones

33%

Nikkei

15%

FTSE 100

None of these considerations means British investors should shun UK funds or shares. Indeed, there are good arguments for denominating most of your assets and income in the same currency as most of your liabilities – such as living expenses – to reduce your exposure to the risk of adverse fluctuations in exchange rates.

 
Enthusiasts can argue that British funds and shares are currently priced in the bargain basement and will bounce back sharply if Brexit proves a success and/or other political fears prove unfounded.
 
Other investors should consider in conjunction with their professional adviser some element of international diversification to diminish risk and gain exposure to global opportunities, whatever the future holds for one country or continent. 

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