With continuing Brexit uncertainty, is it time to hedge your foreign returns to sterling?

For professional investors only.

The value of investments and income derived from them can go down as well as up as a result of market or currency movements and investors may not get back the original amount invested.

Shares purchased on the secondary market cannot usually be sold directly back to the Fund. Secondary market investors must buy and sell ETF shares with the assistance of an intermediary (e.g. a stockbroker) and may incur fees for doing so. In addition, investors may pay more than the current Net Asset Value per Share when buying ETF shares and may receive less than the current Net Asset Value per Share when selling them.


 

As UK investors, it is hard to ignore the constant noise surrounding Brexit. With a defeat and a string of difficult debates in Parliament for various alternative Brexit deals, and a second referendum or even a general election becoming real possibilities, the chances of the UK exiting the EU with no deal or the 29 March deadline being extended are significant. Therefore, the uncertainty is not a short-term issue, and investors alike cannot ignore the Brexit developments and what they mean for markets and portfolios.

 

Any delay or a no-deal exit is likely to have a negative impact on the UK economy, although to differing extents, as continued uncertainty will weigh on UK growth prospects and sterling, leading to businesses delaying investment decisions.

 

 
 

 

That said, UK equities are currently attractively priced from a historical standpoint and, along with other equity markets such as the US and Europe, should benefit from a ‘soft’ Brexit, an extension of Article 50 or a second referendum.

 

Market sentiment towards sterling appears to have turned a corner since January; there are more optimistic market expectations as highlighted by the lower implied volatility for the GBP/USD currency pair.

 

As with any event that is tied to political wrangling (as per the fateful 2016 referendum itself!), it is impossible to predict the eventual outcome, and therefore it would be advisable to consider hedging returns to sterling, for both possible currency appreciation and currency volatility perspectives.

 

The chart below illustrates how a sterling hedge for global investment grade bonds significantly improved the risk-adjusted returns over the long term by dampening volatility.

Opinions expressed by individual authors do not necessarily represent those of BMO Global Asset Management and should not be considered to be a recommendation or solicitation to buy or sell any companies that may be mentioned.