Jeff Salway: Look to the dollar but avoid US market

Investors and pension savers are bracing themselves for a period of turbulence as the UK prepares for an EU referendum that threatens to trigger a fresh crisis in global markets.

Polls this week showing increased support for Brexit prompted a sharp market sell-off and a drop in the value of sterling, amid uncertainty over the economic implications of the UK leaving the EU.

Wednesday saw the benchmark FTSE 100 index suffer its steepest one-day fall since February – regaining some of that ground when campaigning was suspended later in the week – while European shares slipped to a three-month low and the pound fell to its lowest level in two months.

“A vote to leave the EU will have a much more significant impact on markets than a remain vote, creating uncertainty and unsettling investors,” said Adrian Lowcock, head of investing at AXA Wealth.

“It will likely cause sterling and UK stock markets to fall as international investors look to reduce their risk and exposure to the UK by selling shares and other investments.”

Further turbulence is expected next week as the referendum nears, and a Brexit vote could cause chaos over the coming weeks.

The question being asked now by ordinary investors and pension savers is how they can protect themselves from the effects of any downturn that might be around the corner.

There are several measures you can take to limit the downside, said Tom Munro, owner of Tom Munro Financial Solutions in Larbert.

“The most important is managing your currency exposure where relevant, as this has undoubtedly been the most sensitive asset class throughout the whole debate. The solution here is to reduce exposure to Sterling and consider a higher weighting to the US Dollar, Euro and other currencies.”

Reducing exposure to the UK stock market may also be wise over the coming weeks, he added, due to both the referendum and recent poor economic performance.

“Should the vote be to remain, I see a more positive outlook for the UK in the coming months, so gradually ‘phasing back’ to the UK equities would be sensible.”

There’s also a case for focusing on large companies that are more likely to have overseas operations and which would benefit from weaker sterling following a Brexit.

“Such businesses are also less reliant on UK growth, which could be impeded in the event of Brexit,” said David Thomson, chief investment officer at VWM Wealth in Glasgow. “This suggests that these larger companies would outperform small- and mid-cap companies, which tend to be much more domestically exposed and therefore more vulnerable to any weakness in UK growth.”

The temptation for many may be to pile into “safe haven” assets such as gold. The fact that gold is priced in US dollars will add to the attraction if sterling weakens.

One way to invest in gold is through collective funds. “Funds such as the BlackRock Gold and General can be held in virtually any tax wrapper,” said Munro. “Gold does fluctuate in value and should not be considered risk free, but it’s generally regarded as a good shelter in times like these.”

Government bonds (gilts) will prove popular in the event of a post-Brexit flight to safety. The collapse of German ten-year bond yields into negative territory this week – meaning investors are paying to hold them – underlined the demand for security.

“Gilts should perform well but to protect yourself from Sterling weakness investors should also look at overseas bonds particularly US Treasuries,” said Thomson. “Likewise, high-quality investment grade corporate bond may perform well on the coat-tails of gilts and sovereign bonds.”

There is one overarching message for long-term investors however – stay patient, and make sure your investments are diversified. “Ride-out the storm if you have put in place a long-term strategy. Short term volatility will always persist, but it’s generally smoothed-out over longer periods,” said Munro.

FACT BOX

Four sectors that could suffer from Brexit - but benefit from remain:

Financial services: Regulatory uncertainty is a significant risk to financial services. The sector is likely to see some relocation of operations to European centres such as Dublin, Frankfurt, and Paris if the United Kingdom is no longer part of the EU, due to regulatory barriers to operating outside the EU.

Property and housebuilders: London’s importance as a global financial centre is critical to demand for commercial space, which creates risks for London office property. Reduced immigration and/or the potential relocation of some financial services would typically have a negative impact on house prices in London and the South East.

Retailers: In addition to the impact of lower UK growth, products sourced in other currencies would become relatively more expensive if sterling weakened although some retailers may benefit from an inflationary environment. Longer term, there is the risk that tariffs and other operational costs could impede profitability and drive demand abroad.

Travel and leisure: Sterling weakness is likely to affect demand for British travellers to overseas destinations, but also potentially make the United Kingdom a more attractive tourist destination. There are also regulatory issues for airlines if they are no longer operating under the Single Market model, which may add to complexity and costs.

Source: David Thomson, VWM Wealth