With the Brexit Referendum coming down to an exceedingly thin margin between its antagonists, global markets are roiling at the uncertainty, swinging to the tune of each poll leading up to the vote on June 23rd. Following a relatively long period of market complacency as investors banked on polls consistently pointing towards a victory for the Remain side, markets have been down since polling from the beginning of June onwards suggesting a growing majority for the Brexiteers.
Earlier this week, polls again tilted to suggest the U.K. would vote to remain in the European Union, portending further volatility in the days ahead. The Wall Street Journal reports the British Pound rose over 2% against the U.S. Dollar to $1.47. Stoxx Europe 600 jumped 3.6%, Japanese shares rose 2.3% and the Dow ended up 129.71 points (0.7%), while S&P500 added 12.03 points (0.6%), all of which were their strongest performances, respectively, in some time.
“This rally has just underlined how very nervous markets are,” says Morten Helt, analyst with Danske Bank. “You could easily imagine a poll tomorrow showing a majority for the Leave camp, with another volatile reaction in the opposite direction.” Bookmakers, such as betting exchange Betfair, have the odds of Brexit at roughly 23%, down from 40% last week.
Adding to the uncertainty, suggests Matthias Hoppe, Senior Vice President and PM for Franklin Templeton Solutions, is the fact that it is not simply an up-or-down vote according to traditional party lines or geographic constituencies within the U.K., with the Conservative party deeply divided and up to one third of Labour actively campaigning to leave. While the consensus in the Hedge Fund industry anticipates a vote to Remain, the result is virtually unpredictable.
The View from London
The U.K. has roughly 18% of world’s Hedge Fund assets (up from 9% in 2001), according to TheCityUK, a financial services lobbying group. According to Chicago-based Hedge Fund Research, London’s Hedge Funds account for 75-80% of the assets in Europe’s Hedge Fund industry, and have contributed substantially to London’s rise as a global financial centre.
Those advocating Brexit within the U.K. say that in the long term, the UK economy will thrive, as it makes its own trade deals on the models of, say, Norway or Iceland. Norwegian politicians (and influential publications, such as The Economist), given their own experience and difficulties of negotiating bilateral deals under the auspices of WTO rules, however, see such deals as fanciful. In addition, the U.K would have to endure a lengthy process of still having to negotiate exit deals with the European Union itself that will likely keep a lot of the U.K.’s existing commitments – such as payments – at existing or similar levels, with fewer of the benefits, alongside the imposition of tariffs.
Hedge Funds could either reap profits or suffer losses on investments, depending on the referendum’s outcome. For instance, as the Wall Street Journal also reports, Goldman Sachs Group Inc., J.P. Morgan Chase & Co. and Morgan Stanley all fear large costs if a Brexit forces companies to refocus business or relocate employees. “One realistic outcome is that we lose the ability to passport our banking and trading services into Europe,” J.P: Morgan Chairman and Chief Executive James Dimon says, “but our clients will still need us to trade within what will then be the EU.”
Hedge Fund managers, for their part, are emerging from their traditionally restrained public profiles to take sides on the referendum, with some being vocally outspoken in favour of Brexit, in contrast to the majority of the financial industry and banking elites, who favour Remain (however quietly, still smarting from the populist hit to their reputations from the financial crisis). Hedge Fund managers, by contrast, cater to institutional investors who have wealthy owners that are politically active, and have thus been more outspoken.
Among those urging Brexit are Crispin Odey of Odey Asset Management, Paul Marshall of Marshall Wace and Savvas Savouri of Toscafund Asset Management LLP. These individuals see London’s future as a financial centre as secure, irrespective of the outcome of the referendum, and suggest, for example, how Chinese companies would flock to the city because of its workforce and regulatory regime, convinced that London would “thrive and grow” outside the heavy-handed regulation from Brussels which, they claim, has held London back. This view is disputed by those who want to stay, e.g. David Harding of Winton Capital Management, Manny Roman of Man Group PLC (one of the world’s largest hedge funds), and Ewan Kirk of Cantab Capital Partners, who make the case that London and the U.K. have benefited from the EU’s free market for services, such as fund management and insurance.
Medium- to Long-Term Implications
If the U.K. does vote to leave, the long-term consequences for the market are difficult to foresee. Most respectable economists and bankers believe a Brexit would at least temporarily hamper investment and trade with the U.K. The rally earlier this week indicates that investors see Brexit as hurting global growth and sparking a downturn in risk appetite globally, where a bull market, since the financial crisis, is already fragile due to subdued growth and scarce inflation.
According to Robert Olin, Investment Specialist with Danske Invest, given the U.K’s size as a geopolitical and economic actor, there is considerable risk of a vacuum that can perpetuate uncertainty and have serious economic consequences globally. This is one reason many investors have sold off European stocks in recent months, though U.S. investors have only just recently begun to wake up to the implications for American companies. Mr Olin forecasts that a Brexit would weaken the Pound, as investment would continue to exit the U.K., alongside weakening the Euro against the Dollar, as investors would opt for the latter over the former. Mr Hoppe concurs, anticipating that the Pound, already volatile versus the US dollar and Euro as the projected margin between Leave and Remain narrows, would depreciate substantially. This depreciation would likely raise the cost of imports to the U.K., and lead to higher inflation.
Mr Olin also suggests interest rates would fall in stable countries like Germany, Denmark, Sweden and Holland, as well as in the U.K. Conversely, interest rates would rise in Spain, Italy, Portugal and Greece. Investors would demand higher risk premiums on European shares, meaning that prices and markets would fall. Conversely, European exports would benefit, as they could take advantage of the weakened Euro, and banks would profit from the relative stability they offer.
A vote to Remain, on the other hand, would strengthen markets with large cash infusions, strengthening the Pound and the Euro and leading to rising interest rates. Mr Hoppe suggests it would lead to more FDI in the U.K., boosting economic activity and putting upward pressure on inflation. Mr Olin, for his part, says it would also, however, raise the likelihood that the U.S. Federal Reserve will raise interest rates in short order, which could have an adverse effect on the Yuan, and therefore on international investors operating in Chinese and emerging markets. This could equally create uncertainty for the rest of the year.
Jannik Arvesen, Jan Gabrielsen and Bjorn Tore Urdal, the investment team at Norway’s Sector Asset Management’s Sector Sigma Nordic fund, suggest Brexit could also be a potential catalyst for equity correction in coming months, confounding the so-called “TINA” theory (“There Is No Alternative,” with rates at zero, to the further broad expansion in equities markets and valuation multiples), with fears of Brexit engulfing European equity markets in which financial markets were previously supremely confident of a Remain vote. With government bonds at zero or below and more equity market volatility and lower, or at least highly unpredictable, variable equity market returns, Sector Sigma suggests a period of structural decline in the expected pace of future global growth may be in store.
Where There’s A Will
Nigel Green, founder and chief executive of deVere Group, one of the world’s largest independent financial advisory organisations with more than $10b under advice, however, suggests savvy investors will capitalize on post-Brexit referendum volatility in global financial markets, regardless of the outcome.
“Naturally, global financial markets fluctuate in response to events such as referendums, general elections and other major geopolitical situations, both in the run up and afterwards,” Mr Green says. “But with the EU referendum so close and therefore so unpredictable, and with its outcome having such a far-reaching and long-term impact, it is likely that the markets will react perhaps more than they would under other circumstances.”
Mr Green nonetheless expects that investors will be in the position to capitalize on the post-Brexit referendum volatility in global financial markets, whatever the outcome, and thereby be poised to take advantage of the anticipated fluctuations. Indeed, Mr Hoppe, for example, stated Franklin Templeton’s intention to position portfolios to accommodate either outcome.
“Whilst some people are put off from investing because of volatility, many of the most successful investors welcome it. This is because profitable opportunities are found when there are fluctuations,” Mr Green continues. “Fluctuations can cause panic selling and mispricing. High quality equities can then, for example, become cheaper, meaning investors can top up their portfolios and or take advantage of lower entry points. This all, in turn, means greater potential returns.”
“Whatever the economic repercussions for Britain’s, Europe’s and the global economy’s, investors will find ways to profit as the world readjusts to a post-Brexit referendum reality.”