How investors can protect themselves from the Brexit vote turbulence
It's almost D-Day for the UK electorate. John Mattimoe outlines how investors should view a vote to leave the EU
Investors generally do not like to be exposed to a major binary event. The upcoming Brexit referendum is one such event - either the UK will vote to remain in the EU or it won't.
So what can investors do to protect themselves? Often there is a temptation to run towards so-called 'safe haven' assets, which have traditionally included gold, government bonds or Swiss francs.
After the market turmoil of recent years, however, perceived 'safe havens' have seen huge volatility. Many investors can share tales of woe from investing in assets that they thought were safe but which subsequently saw massive sell-offs.
With the Brexit referendum, the situation is complex. Investors need to prepare for two potential outcomes that could have markedly different consequences.
An investor who fears the UK will vote to leave the EU could choose to reduce their exposure to British facing plcs or to the pound sterling. If they do, however, they run the risk of missing a major rally in these assets if the vote goes the other way.
There is little to be gained from seeking protection from one outcome with a strategy that involves significant downside exposure to a different outcome - particularly in a referendum which many observers seem to have agreed is now too close to call.
What we have seen over the past six months is further demonstration that markets dislike uncertainty. Sterling has fallen about 10pc against the euro since November - but even this fall has involved significant short-term fluctuations.
Still, it's worth remembering that markets have been selective in picking out which assets are more exposed to Brexit than others.
Many equities that are thought of as British but which have global operations have seen few if any sell-offs. In these cases, the markets have taken a view that, despite their British headquarters, their global operations will continue to be as profitable as before.
By contrast, companies that are a more direct play on the UK economy, such as quoted housebuilders, have been in the firing line and have seen share price falls in the region of 20pc off recent peaks.
Speculation on the outcome of the vote holds little attraction for investors at this stage. It would not be surprising to see a significant knee-jerk reaction to whichever result emerges, followed by a calmer period during which the outcome will be analysed in a more considered manner.
Markets often react with heavy bursts of selling or buying in the hours after a major event, only to settle down in subsequent days and sometimes reverse much of the rally or fall that has just taken place.
So how might investors cope with any period of significant volatility that might follow the vote, or indeed any event that causes volatility?
In general, investors that have followed the tried and tested model of building a portfolio that is diversified across asset classes and geographical areas tend to be most comfortable with periods of short-term volatility. Such portfolios tend to be based on high-quality, well-chosen assets spanning equities, bonds, commodities and cash, purchased at attractive valuations. A portfolio of high-quality assets constructed this way will be well placed to deliver attractive returns over the longer term while managing risks in a sensible manner.
Investors should satisfy themselves that the level of risk in their portfolio is in line with their risk appetite - ie, if they are not happy to take significant risk on the outcome of a specific event, such as Brexit, their portfolio should be structured accordingly.
Essentially investors need to ensure that they have an investment strategy that is capable of delivering its target level of return over time within their risk parameters. Such a strategy is likely to be required to be dynamically managed to manage risks as they evolve and to be able to take advantage of opportunities that arise during bouts of volatility.
As we have seen in the past, market concerns over a significant event are quickly replaced by a new set of concerns as investors move on to the next set of uncertainties.
After the referendum, markets will still have to contend with uncertainties such as the US election and what that might mean for global trade and economic growth; the impact on European economies of mass migration from the Middle East; the ongoing issue of Greek debt; the likely timing and pace of US interest rate increases; and the direction of oil and energy prices.
Regardless of the Brexit outcome or other risky events, it is important for investors to have an investment strategy that is capable of navigating through such uncertainties as they arise in order to satisfy their longer-term investment objectives.
John Mattimoe is head of equity analysis at Appian Asset Management, which is regulated by the Central Bank. Views do not constitute investment advice
Sunday Indo Business