For instance, a falling pound isn’t necessarily bad news from a portfolio perspective. For a sterling investor with investments across different geographies, the positive impact of foreign currency exposure can be quite large over time when the pound is weak.
If the US equity market falls by 5% and US dollar rise by 10% versus sterling, then all else equal, the UK investor sees a positive return of 5%. Indeed, most global portfolios actually delivered positive returns directly after the referendum, despite a sharp fall in the FTSE.
Understanding this relationship is increasingly important because sterling is likely to continue to be volatile during this period of uncertainty.
The big question is: does Brexit risk remain localised to the UK or will it pull other countries into recession? This is not our base case, but we continue to watch for signs of weakness.
In the short term, we expect markets to remain volatile. However, volatility can create opportunity. By remaining diversified, investors can aim to reduce some of this volatility while keeping their portfolios aligned with their attitude to risk, focusing on areas that look most attractive from a risk/reward perspective.
Areas which would appear to face greater headwinds following recent events include domestically facing UK mid-cap stocks and European equities. In addition, while the pound has fallen a long way, it would not appear to be obviously cheap at current levels.
Yet with rates now likely to stay lower for even longer, emerging market hard currency debt and global real estate investment trusts look attractive. Both asset classes have limited European exposure, but could benefit from central banks’ desire to remain supportive.
Although it is difficult, investors should try to look through short-term market noise, remain diversified across different regions and asset classes, and focus on their end investment goals.