Brexit: What It Could Mean for Investors

Britain Votes on Its EU Membership in June 2016

Getty Images / Julian Elliott Photography.

Britain has a checkered history with the European Union. While the country doesn’t use the euro as a common currency, it must comply with rules made by the EU parliament regarding budgets, transportation, energy, and consumer rights. The decision to join the euro in the 1970s helped solidify London’s status as a global financial hub, but in 2015 and 2016, concerns have arisen over border security following the Syrian refugee crisis.

In 2016, Prime Minister David Cameron announced a referendum to decide whether or not the country will remain in the European Union or “Brexit” from it. The move indicates a growing frustration with the EU’s politics among British citizens, but in reality, the country could suffer through an economic downturn if it were to exit the region. After all, it’s economy is heavily dependent on both trade and financial services within the EU membership.

In this article, we’ll take a look at the likelihood of a “Brexit” and what it means for international investors with exposure to the region.

What’s the Likelihood of a Brexit?

The polls may be neck-and-neck in Britain, as of late-February 2016, but history shows that pragmatism tends to prevail. With several months remaining until the decision is made in late-June 2016, politicians are likely to make clear the costs of such a move and address many of the underlying reasons that citizens would like to move outside the region.

The cost of exiting the European Union could be significant. If it were to leave, the country could see an immediate drop in its exports as tariffs would likely be imposed on its trade to other members of the union. London’s status as a financial hub could also experience a slowdown as new regulations would likely be placed on currency transactions between it and the rest of the EU member countries if it were to leave the region.

In addition to the high cost of leaving, the reasons to leave may also be mitigated over the coming months. The U.K. negotiated a provision that enables it to block immigration by people that it believes present a security risk – even if they have no prior record, while it may also limit welfare benefits for migrant workers. The U.K. is also allowed to block, delay, and negotiate any amendments or regulations that inhibit its financial services sector, including future bailouts.

Scotland’s referendum to exit the United Kingdom back in late-2014 further illustrates that popular polls can be misleading and most voters think pragmatically. That is, polls may demonstrate that people are fed up by specific issues, but the cost of leaving the EU tends to take precedence over these concerns when it’s decision time.

Volatility is More of a Certainty

Britain may not ultimately exit the European Union, but the uncertainty surrounding the decision can make life more difficult for international investors.

The markets exhibited a high level of volatility leading up to the Scottish Independence vote even though the referendum ultimately failed. While not entirely attributable to the vote, the MSCI World Index moved 8% within the two months leading up to the vote amid the uncertainty surrounding the country’s critical status in the U.K.

This kind of volatility is likely to appear in the months leading up to the British vote, even if the ultimate decision is likely to be “no”. With the European Union’s weak economic state, this volatility could amplify built-in concerns about the region’s economy.

Investors may want to prepare for this volatility by adjusting their asset allocations and potentially hedging their bets using options or other volatility hedges. At the same time, it’s important to main a diversified portfolio to limit exposure to a single region – like the European Union – in the event that a worst-case scenario does occur.

Key Takeaway Points

  • Britain has a checked history with the European Union that has been exacerbated by the Syrian migrant crisis and bailouts from the sovereign debt crisis.
  • Prime Minister David Cameron introduced a referendum to decide whether or not it will remain in the European Union on June 23rd.
  • A “Brexit” is unlikely to occur, if history is any indicator, but the markets are likely to see significant volatility leading up to the decision.