Should you hedge your bets on a Brexit?

What you can do right now to reduce your risk from Thursday’s vote

There is a great deal of uncertainty over the likelihood, and consequences, of the vote on 23 June. However, disagreement is mainly over the magnitude of what will happen in the long run, and not over the direction things will move right away.

Most economists believe that ‘markets are efficient’ at least in a certain sense that they reflect the consensus of expectations. This means that before uncertain outcomes (like the EU referendum) are resolved, the price of assets will be somewhere between the anticipated value after each outcome, here ‘Brexit’ or ‘Bremain’. This includes currencies, stocks and shares, and physical goods like housing.

Consider some of the things that may be most relevant to your long-term financial health (this list is far from comprehensive).

In the event of a ‘Leave’ vote, the consensus wisdom, (in order from more to less certain) is that:

  1. The British Pound will fall in value against the Euro
  2. Both the Euro and the Pound will fall in value against the dollar and other international currencies
  3. UK house prices will fall, (although this may take some time to be fully realised, as the housing market adjusts slowly)
  4. UK stocks and shares (FTSE) will fall in value overall (in international currency, and possibly in sterling terms)
  5. UK firms that depend on exporting from and importing to the EU will be harmed (at least in the medium run), seeing their share values fall and potentially having to lay off workers
  6. UK firms that face European competition in the domestic market will be able to raise prices and/or increase market share, and thus increase profits and see their share values ris

Because ‘markets reflect expectations,’ if the Remain camp wins, the exact opposite of each of the above seems likely. I.e.:

  1. The British Pound will rise in value against the Euro
  2. Both the Euro and the Pound will rise in value against the dollar and other international currencies
  3. UK house prices will rise (note that this rise may happen quicker than the fall predicted above, as housing prices tend to be more ‘sticky’ downwards)
  4. UK stocks and shares (FTSE) will rise in value overall (in international currency, and possibly in sterling terms)
  5. UK firms that depend on EU exporting/importing will be helped (at least in the medium run), seeing their share values fall and potentially choosing to hire more workers
  6. UK firms that face European competition in the domestic market will anticipate lower profits (relative to the previous expectation), and their share values will fall.

How does this affect you?

This depends on your own situation, particularly your employment, your housing situation, your long-term retirement plans, and your current investment portfolio.

Are you a Brexit-loser (and a Bremain-winner)?

For example, if, as for many in the UK, your home is your largest asset, and you’re planning to ‘cash out’ and buy a cheaper house and use some of the difference towards your retirement, the Brexit may hurt you. The Brexit will be all the more harmful if you’re planning to retire outside of the UK, as Sterling is likely to be worth less. (This is particularly harmful if you are sending money to family members abroad?) Do you hold large share of your portfolio in UK stocks, particularly those involved in import and export to the EU? Does your job depend on this?

If this is the case then you are likely to be hurt, in net, from Brexit.

Are you a Brexit-winner (and a Bremain loser)?

Conversely, if you are consider becoming a first-time homebuyer the Brexit may help your finances, and Remain vote will hurt them. This may also be the case if you hold assets or income streams coming from outside the UK but you spend your money in Britain, or hold investments or a stake in a business that will benefit from less competition from continental Europe.

What can you do about it?

Recent articles suggest you should purchase holidays and cheese in advance. These are clever ideas, but laughably small-scale.

If markets are reasonably efficient, there is probably no way that you can act now to ‘always profit’ or even to ‘profit on average’. However, what you can do is to hedge your bets. When we make financial and life plans and decisions, most of us prefer to set things up so that we face the risk of only a small loss or gain, rather than a much larger loss or gain. You would rather have a large chance of being comfortably middle-class than an even chance of being either a millionaire or destitute.

You can help ensure that, whatever the outcome, your losses will be limited by ‘betting against yourself.’ (This will be, of course, at the cost of reducing your gains in the event the vote goes in your favour.)

If you are a Brexit-loser, you could do some combination of the following:

  • Place a bet that ‘leave’ will win (with a bookmaker that doesn’t take to large a commission and gives good odds)
  • Move your sterling into other currencies (buy dollars or Euros)
  • Move your investments into funds that invest in markets denominated in other currencies (be careful when shifting your investments that you do not incur a large penalty or commission)
  • Invest in firms that are likely to benefit from Brexit, and reduce your investments in those that are likely to suffer
  •  Reduce your ‘exposure’ to UK housing (this may be somewhat difficult to do unless you are on the verge of a house purchase or sale)

If you are a Brexit-winner, you could do some combination of the following (essentially, the opposite of the above, but the housing investment is easier to do):

  • Increase your ‘exposure’ to UK housing buy buying ‘residential property bond’ or a fund that invests in residential property or buy-to-let (but beware of large management fees)
  • Place a bet that ‘remain’ will win (with a bookmaker that doesn’t take to large a commission and gives good odds)
  •  Increase your ‘exposure’ to UK housing (this may be somewhat difficult to do unless you are on the verge of a house purchase or sale)
  • Move your other currency holdings into sterling
  • Move your investments out of funds that invest in markets denominated in other currencies (be careful when shifting your investments that you do not incur a large penalty or commission)
  • Reduce your investment in firms that are likely to benefit from Brexit, and increase your investments in those that are likely to suffer

Your choice of the above options should depend both on the cost of these (fees/commissions etc.) and on which of the above effects are most relevant to you. Although the above is conventional wisdom, there is far from a complete agreement about all of these, and you may want focus your hedging on the one that affects you most. If you are particularly concerned about UK housing prices rising (e.g., you are on the verge of being a first-time homebuyer), for example, you may want to buy a fund that invests in UK residential property.

Will you follow this advice? Will you feel good about it?

Economists have evidence that people do not always seem to make financial decisions in their best interest, at least not in the conventional sense. We are impatient. We are particularly sensitive to ‘losses relative to a reference point’, rather than just considering the overall outcomes. We tend to regret actions more than inaction and we regret the losses that occur because we didn’t follow the status quo. Suppose you could invest in something guaranteed to pay a 20% return in one year if a fair die rolled 1-5, and only incur a 5% loss if the die rolled a six. By most measures,this would be a great investment. If you invested £100,000 in this and were unlucky enough to have lost (£5000) you might regret having made this decision, even though it was a good choice in advance.

If you will be mentally kicking yourself for any losses relative to having ‘done nothing’ you may not want to take the above advice, for psychological reasons. On the other hand, if you can be mentally at peace with hedging your bets, and any mental distress in the case where you ‘lose from the bet and win from the referendum’ (or vice versa) will be outweighed by the benefits of ‘winning from the bet when you lose from the vote’, then you may want to hedge your bet on Brexit.

 

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One thought on “Should you hedge your bets on a Brexit?

  1. Jonquil Lowe makes similar points (about the impact, not about hedging) in her piece Four ways Brexit will hit personal finances

    And although the vote has passed, there is still room for households to insure themselves against major losses from what might happen next. The interest rate is, of course, one of the big uncertainties, as well as of course the terms of future trade relations with the EU, and Scottish independence.

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