Should you buy the FTSE 100 and sell the FTSE 250 to hedge against Brexit?

With the EU referendum less than a month away, many investors may be wondering what the potential effects of the vote could be. Clearly, if Britain votes to stay in the EU then investors are likely to feel more optimistic about the near-term future, since it brings continuity and greater certainty.

However, a vote to leave could cause a degree of volatility in the short run and cause share prices to come under pressure. That’s because change brings uncertainty and history shows that investors don’t usually adopt a risk-on attitude during such a scenario.

Despite this, the impact on the FTSE 100 of Brexit may be less than many investors currently believe. That’s because the UK’s main share index is made up almost exclusively of international companies for which the UK market is a relatively small part of their sales mix. This means that even if the UK economy endures a tough period, resources companies and international consumer goods companies for example are unlikely to suffer greatly in terms of their top and bottom-line performance.

UK focus

However, FTSE 250 stocks may experience a rather different response to Brexit. That’s largely because they tend to be more domestically-focused than their FTSE 100 peers, and so doubts about the short-term performance of the UK economy could hurt their share prices to a greater extent than the FTSE 100. And with them being smaller companies, they may have less diversity and financial strength than their larger peers, which could lead to reduced demand from investors as they seek out assets that are perceived to be lower risk.

Therefore, many investors may feel as though buying the FTSE 100 and selling the FTSE 250 may be a prudent move ahead of the EU referendum, with it having the potential to act as a hedge of sorts against Brexit.

Think twice

Clearly, there’s some merit in this idea for the reasons given above. However, the truth is that nobody can accurately assess exactly what will happen if Brexit occurs. That’s because it’s an unprecedented event and it’s unclear whether Britain will ultimately be better off in or out in the long run. Likewise, investors’ opinions on the idea are also somewhat opaque and the impact of such a decision on the FTSE 100 versus the FTSE 250 is also very unclear. It could be the case that both perform badly, well or a mixture of the two.

Therefore, the logical step for most investors to take seems to be to go back to investing basics. In other words, buy high quality companies when they’re trading at sensible prices, and hold for the long term. Furthermore, keep some cash on hand so that if Brexit or any other event causes a fall in share prices, there’s scope to buy those same high quality assets at even more attractive prices.

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Peter Stephens has no position in any shares mentioned. The Motley Fool UK has no position in any of the shares mentioned. We Fools don't all hold the same opinions, but we all believe that considering a diverse range of insights makes us better investors.