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How to diversify Brexit risk

A few weeks ago, I wrote that with the risk of Hard Brexit still clearly on the table – but with softer outcomes still within reach – it made sense to diversify your portfolio to better prepare for any outcome.

Since then, the storm clouds have darkened somewhat:

  • Bank of England governor Mark Carney warns the risk of a No-Deal Brexit is “uncomfortably high”.
  • Trade secretary and arch-Brexiteer Liam Fox puts the probability of a Hard Brexit at 60%.
  • Even the life-long Eurosceptic MP Jacob Rees-Mogg has warned the benefits he sees from Britain going its own way may play out over 50 years, not a few volatile months.

I don’t intend to predict what might happen to the economy in the different scenarios. In the short term, it arguably doesn’t matter. That’s because short-term asset prices are determined mostly by what people believe.

As legendary investor Ben Graham put it, over shorter time horizons the market is a voting machine – in the long term it becomes a weighing machine.

A hit from Hard Brexit could even be a self-fulfilling prophecy. If enough investors believe prices could fall, then they probably will.

Five big diversifiers

Most investors will want to be ready for any potential Brexit-related choppiness. And happily, diversifying your investment portfolio to protect against a potentially chaotic scenario is relatively easy.

Better still, whatever the outcome, economic theory says diversification can reduce the level of risk in your portfolio, while still enabling you to capture the bulk of the gains you would expect to get from owning shares.

Indeed, diversification has been described as the only free lunch in investing. So, what are you waiting for?

Here are five quick ways you can build a Brexit buffer.

Own global shares

The single best way to diversify your equity portfolio is for most of it to be in foreign shares.

The UK stock market makes up less than a tenth of the total global stock market capitalisation, and even then, we’re punching well above our weight in GDP terms.

A hard Brexit may make news headlines around the world, but it won’t disrupt world trade much and shouldn’t hurt global investor sentiment. In contrast, even though UK companies earn over 70% of their money abroad, they could be dumped in a kneejerk reaction like we’ve seen in the past.

It’s easy to get global exposure with a few keystrokes by putting your money into a world equity index tracker fund or ETF.

Buy gold

Gold has been the go-to asset in times of chaos for millennia. Its performance is not correlated to mainstream assets like shares and bonds, which means it can be a genuine diversifier.

I wouldn’t expect the dollar-denominated price to move much on Brexit developments, but effectively you’re also diversifying away from the pound if you own gold.

Purists say you must own physical gold to get the full benefit. But given we don’t expect the breakdown of the global financial system with a Hard Brexit, so buying a gold ETF would seem appropriate.

Invest in US Treasuries

US Treasuries – that is US government bonds – are another asset investors flock to in times of panic.

You can get exposure via an ETF. Normally it’s advisable to own any foreign bonds in a fund that’s hedged back to the pound, to reduce your currency risk.

However, in this instance, you may explicitly want exposure to the US dollar, as all else being equal, dollar-denominated assets should rise in value if the pound sells off.

Buy UK government bonds (gilts)

Even though the Bank of England has started gradually inching up the Bank Rate, the yields on UK government bonds remain paltry. You’re also not exposed to currency risk with the money you invest in gilts – normally a good thing, but in this instance, you may want foreign currency exposure to diversify against a bad Brexit.

The case for gilts is simply that they’re considered a safe haven and might go up in value if UK shares fall after a Hard Brexit is confirmed. They can be bought via index funds and ETFs, or alternatively you can buy and hold individual gilts directly via most brokers.

Buy British

The assets I’ve described so far should provide solace if there’s a Hard Brexit – but all outcomes still appear to be on the table. With the pound already looking pretty cheap against the dollar and Euro, and with Brexit having been in the news non-stop for two years, it may be bad outcomes are already priced into the exchange rate and the UK stock market.

Someone very nervous about a Hard Brexit could put all their money into foreign shares and other non-Sterling assets, and then be wrong-footed if a deal is reached, or even if the pound and UK market rally once some certainty is established.

British shares have been relatively unpopular these past two years, and they may now offer better value than overseas companies. UK mid and small caps seem the best hunting grounds to get more British bangs for your investing bucks.

Vote for variety

How much (if any) of each of these assets to own is a personal decision. It also depends on factors such as your age and your overall risk appetite.

The point is if you’re sailing towards Brexit with a typical DIY stock pickers’ portfolio of a dozen UK shares, you might be taking more Brexit risk than you need to.

Properly diversifying should stand you in good stead throughout your investing life, long after Brexit is finally off the front page each day!

Are You Prepared For Brexit?

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