With all conceivable Brexit outcomes still possible, specialist international banking and asset management group, Investec, has put together a schematic graphic to illustrate the impact of the various scenarios on investments.
This is followed by Investec’s explanation and reasoning behind the schematic.
Our ‘decision tree’ starts with a judgement (based purely on instinct) of whether or not the UK will indeed leave the European Union on 31st October. The probability and implications of a no confidence vote before that date are embodied within this.
Next, we attempt to assess whether, if Brexit happens on the 31st, it will be hard or soft. Otherwise, if we have not left on that date, we must wonder whether there will be an election to break the cross-party logjam. This means that if there is an election, we must speculate as to whether it will result in a new Brexit referendum. If that is indeed the case, we need to therefore judge whether Brexit will be accepted or rejected.
Based on the path taken, we have labelled the possible outcomes as ‘Short & Sharp’ (hard Brexit), ‘Most Benign’ (soft Brexit), ‘Delay’ (delayed Brexit) and ‘Limbo’ (no material clarifications or change in the situation). The probabilities assigned to each of the preceding steps determines the probability of the outcome.
In the worked example above, we end up with a near 50% chance of a hard Brexit, with an additional
cumulative 25% chance of a soft Brexit either on 31st October, or one delayed but ultimately implemented after an election and/or second referendum. If these assessments are accurate, it leaves a 25% chance of a continued state of Limbo. This analysis does not assess explicitly the possibility of rejecting article 50, which would form a part of this last set of outcomes – the 25% that leaves us no more certain of our future, at least in the near term.
Having outlined a set of possible outcomes and their associated probabilities, we made an estimate at the impact on a notional balanced portfolio invested 60% in equities and 40% in a range of other assets. Taking the view that Brexit will primarily impact assets with UK economic exposure, the impact assessment is based on a view of the sensitivity of each asset class to sterling currency volatility.
We estimate (as outlined above) the probability of some form of Brexit, on or soon after 31st October, to be over 70%. The probability of a hard Brexit is just under 50%.
Hard Brexit Impact: If our logic and estimates of the probabilities are close to right, and assuming
similar asset class impacts to the period around the Brexit vote, a hard Brexit on 31st October would see sterling-denominated portfolios rise by a low a single digit percentage. The main driver would be the assumed 10% fall in £/$, meaning any non-sterling economic exposure would be revalued upwards due to currency translation effects.
Soft Brexit Impact: For a mirror image of the same reason (sterling appreciation repricing non-sterling economically exposed assets downwards purely due to translation), a soft Brexit could see a fall in sterling denominated balanced portfolios of similar magnitude.
Impact of a Non-Decisive Outcome on 31st October: If the UK again finds itself in Limbo, we would expect little movement to sterling-denominated balanced portfolios, as only a small change weakening in the exchange rate would be offset by more sluggish domestic economic growth expectations. Should Sterling move sharply one way or the other from today ($1.21/£), as we head towards the deadline, the ultimate impact in each case outlined above will be dampened.
We would emphasise that we are not judging Brexit as right or wrong. We are only attempting to assess the impact on investment portfolios. Our judgements are made on a best efforts basis and, even if we are close to the mark in our outlook, real client portfolios will inevitably be different to the ‘model’ used here. Nevertheless, we hope you find this thought experiment useful.
Please note that this article does not constitute advice and is for illustrative purposes only. Please contact your Brunsdon Financial Adviser for personal advice.