The fallout of the UK leaving the European Union is the second biggest tail risk keeping global asset allocators awake at night, according to a closely watched survey of fund managers, although heavyweights from the UK industry like Neil Woodford and Terry Smith argue that this would not as big an event for markets as many might fear.
The UK will go to the polls on 23 June and vote whether the UK should remain in or leave the EU. As would be expected, the referendum is provoking a swell of media attention, even if the uncertainty is seemingly yet to fully manifest itself in markets – the FTSE 100 is up 1.3 per cent over 2016 to date, having shaken off some early declines.
Performance of indices over 2016 in local currency
Source: FE Analytics
Capital Economics, however, thinks there are signs that investors are becoming increasingly nervous about how the potential Brexit would affect UK markets.
“Despite the recent recovery in most UK markets, there is still evidence that they are bracing themselves for a possible Brexit. Accordingly, we think there is scope for markets to move significantly further when the result of the vote becomes known on 23 June,” the macroeconomic forecasting consultancy said.
“Despite the recent rebound, equity markets appear worried about the possible impact of a Brexit. Investors have been purchasing put options in order to protect themselves against a drop in the FTSE 100 should the UK vote to leave the EU, as 180-day option-implied volatility for the index has spiked recently. Indeed, it remains higher than over most of the past three years.”
These concerns are reflected in the most recent edition of the Bank of America Merrill Lynch Global Fund Manager Survey, which polled 164 participants with combined assets under management of $493bn on their current asset allocation and investment outlook.
It found that Brexit has become the second biggest tail risk among global asset allocators, overtaking a US recession, renminbi devaluation and an emerging market/energy debt default on their list of overarching worries. Some 19 per cent of fund manager cited Brexit as a significant concern.
As the graph on the flow page shows, ‘quantitative failure’ – or a negative blowback from extraordinary monetary policies such as massive quantitative easing and ultra-low interest rates – remains fund managers’ biggest fear with 21 per cent of the vote.
Source: BofA Merrill Lynch Global Fund Manager Survey
Despite many fund managers’ concerns around the potential event, however, most do not expect the UK to actually leave the European Union. Only 14 per cent see a Brexit as being ‘likely’ while close to half said such an event was ‘unlikely’.
Some fund managers point out that this uncertainty around the referendum’s outcome means that it is imprudent to take any portfolio action at the moment.
John Chatfeild-Roberts, head of Jupiter’s Merlin multi-manager range, said: “It’s a completely binary situation and I find it very difficult to act until we actually know the result.”
“We saw in the general election and Scottish referendum how the polls aren’t necessarily as accurate as you might like. This means to base your investment strategy on the back of what you think might happen is probably not the course of action to follow.”
Some major institutions share the view that a potential Brexit is an event worth worrying about. The International Monetary Fund recently said that a UK exit from the EU could lead to “severe regional and global damage”.
The IMF has cut the UK’s economy’s expected growth for 2016 from 2.2 per cent three months ago to just 1.9 per cent in its most recent outlook. It warns that leaving the EU would not only damage the domestic economy, but the global one too.
"The planned June referendum on European Union membership has already created uncertainty for investors; a 'Brexit' could do severe regional and global damage by disrupting established trading relationships," the Washington-based organisation said in its latest World Economic Outlook.
However, at a recent event hosted by Jupiter Asset Management, Terry Smith and Neil Woodford argued that the impact of a potential exit from the union could be taken in stride by markets and said the doomsday scenario predicted by some is unlikely to play out.
Like the managers surveyed by Bank of America Merrill Lynch, Smith runs a global portfolio but he remains relatively sanguine about the referendum.
Smith, manager of top-performing Fundsmith Equity fund, said: “We are doing nothing, because we don’t think it will have any effect that is predictable or significant. Our businesses are spread around the world far beyond UK and Europe, selling everyday necessities. Therefore, I think they’ll be relatively unaffected.”
Performance of fund vs sector and index since launch
Source: FE Analytics
Woodford, who runs the CF Woodford Equity Income fund, is also holding off on making any adjustments to his portfolio as he does not see either outcome as affecting the long-term investment case for the UK companies he holds.
“We’ve done nothing because importantly we don’t think it would make a significant difference to the performance of the economy over the long term – but that’s not to say there wouldn’t be volatility in the short term. In the event of the country voting to leave, there would be short-term stress so markets and the currency would come under pressure,” the manager said.
“But all those ‘useful’ insights from the IMF and the like I find a) predictable and b) not terribly helpful. My view is that we will navigate our way through the short-term ups and downs that will follow whatever happens and it won’t change our overall strategy.”
