What does Brexit mean for investors?

Anticipation is growing in advance of the UK’s 23 June referendum on its European Union membership. The key battle lines for a potential British exit—colloquially known as “Brexit”—have already been drawn on the issues of immigration, political and financial accountability, and bureaucracy. Yet rather than focus on these qualitative and political topics, we find it more helpful to focus on the UK and EU’s distinct perspectives on two separate scenarios: Brexit and Brexin.

Scenario 1: Brexit is approved
The view from the UK:
While bookmakers see only a 25 per cent chance of Brexit, the Scottish Independence referendum of 2014 makes others think differently. Clearly, polls can be misleading and there may be a larger-than-normal group of undecided voters influencing the outcome. If the pro-Brexit camp wins, a range of scenarios could play out in the UK:

• Domestic political tensions could rise and lead to another debilitating referendum if, despite Scotland’s recent vote to remain in the UK, the UK votes to leave the EU.
• Uncertainty over treaty renegotiations would lead to less inward investment but not have much immediate impact; both the UK and the EU wish to remain constructive trading partners.
• Don’t expect a major shift away from London as a major financial centre; the euro zone simply doesn’t have the essential financial and support infrastructure to replace it.
• Do expect some medium-term consequences if euro-related financing activities are “onshored” to euro-zone countries.
• Investment conclusions for the UK:
  • If the Brexit camp wins, the British pound sterling, as well as UK gilts and bonds, would likely come under pressure.
  • A weaker sterling would help FTSE-listed companies that earn significant revenue overseas; many have underperformed due to the strong pound and to commoditymarket volatility.
  • Brexit would generally be more positive for UK equities than bonds.

The view from the EU:
Brexit would undoubtedly be a blow to the prestige of the European vision at a political level, but it could allow an easier transition to “the United States of Europe” as fiscal unification and the establishment of a transfer union become easier. Indeed, Brexit may prompt serious reflection by some member states about the future of Europe, and this could lead to a clearer vision for all.

However, if other countries feel the UK cherrypicked its membership and relationships, there may well be more political strife – particularly with migration increasing the popularity of nationalist politicians, especially in France; and with new evidence that Germany is making unilateral decisions for Europe, as it did with Turkey.

Europe has less at risk economically from Brexit than the UK, but that could change if political conditions worsen. Nevertheless, the current arguments against Brexit may be too apocalyptic.

Investment conclusions for the EU:

• Brexit could be a “Pandora’s box” for the EU as a whole; if other countries see their own exits as viable policy options, we may see wider fixed-income spreads and greater asset-price volatility in at-risk countries.
• If a pro-Brexit vote prompts countries to test the idea of leaving the euro, that could lead to volatility and an opportunity to invest in attractive assets at lower prices.

Scenario 2: The Brexin camp wins
The view from the UK:
A “no” vote on Brexit, which we believe is the more likely outcome, would be positive for internal investment, since the UK has one of the most competitive and flexible European labour forces, and positive for the political credibility of Europe. Moreover, Prime Minister David Cameron would remain in charge, which would ensure policy continuity for four more years. The UK would still wrestle with many policies that the EU wants to implement, but it is easier to advocate policy from within than without. Throughout this time, we expect the Bank of England to stand pat on monetary policy.

Investment conclusions for the UK:

• Much uncertainty would be removed and the risks around both trade and the role of London would be clarified.
• The UK would remain able to shape the future of the EU and to promote the muchneeded reforms that Europe still needs to implement.

The view from the EU:
While Brexin would reassure the EU’s political credibility on the world stage, a “two-speed” Europe would find it harder to move toward more integration. The UK would continue to remain a non-euro member and guard jealously any further moves that would affect its ability to act independently. Brexin may also make additional integration more difficult; perhaps France and Germany would prefer to “shrink to grow” by losing members who do not share their strategic vision of a United States of Europe.

Even if the Brexin camp wins, we expect more asset-class volatility from other political developments.

Investment conclusions for the UK:

• Europe faces other challenging political events in 2016 and 2017, including elections in Spain, Ireland, Germany, France and Italy. Thus, even if the Brexin camp wins, we expect more asset-class volatility from other political developments.
• Although a no vote on Brexit would lay to rest some concerns over the political direction of Europe as a whole, significant policy choices remain if Europe is to create the proper foundations for a new economic, fiscal and political future.
• A clear vision for the EU for the next 25 years is badly needed to address the tough times that many have endured since the financial crisis; without this vision, investors may  again doubt the EU’s commitment to the euro and related assets.

- Neil Dwane -

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