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08 August 2017
The British vote to leave the European Union (EU) on June 23 2016 shocked global markets.
The UK’s referendum on EU membership had been expected to deliver a vote to remain in the political union, and markets responded dramatically once results started flowing against the latest opinion polls and in favour of ‘Brexit’.
The value of the UK pound (£) plummeted overnight compared to other major international currencies. Relative to the US dollar ($), the global benchmark currency, the pound fell to a 30-year low.
$1.50 – £1 at 10pm on June 23 2016, when polls closed
$1.34 – £1 at 5am on June 24 2016, after the result announcement
Following this post-referendum devaluation, the real value of assets denominated in pounds – such as UK property, UK bank savings, and UK-listed company shares – effectively fell by 11% compared to assets valued in US dollars.
While an extreme example of currency fluctuation, this devaluation of the pound illustrates how an investment portfolio comprised of assets valued in a single currency can be subject to greater price volatility than one spread across different currencies.
Let’s take a simplified example of a portfolio comprised half of dollar-denominated assets and half of pound-denominated assets. While pound assets fell in relative value after the referendum result, dollar assets rose. The overall value of this blended portfolio, in real terms, will have therefore remained relatively unmoved by currency market fluctuations after the Brexit vote.
Diversification by currency is important, but alone will not necessarily fully insulate an investment portfolio from market volatility.
After all, stockmarkets around the world fell on June 24 2016 – in fact, the S&P 500, a benchmark index of the largest US-listed company shares, fell by 3.6%, more than the 3.2% fall by the FTSE 100 Index of UK-listed shares (in local currency).
An effectively diversified portfolio will be composed of more than one asset class, so not simply company shares or property alone, for example. Different types of assets tend to perform differently under the same circumstances.
In the wake of the Brexit vote, the price of mainstream government bonds – traditionally seen as among the lowest risk investments – rose with investor demand for less risky assets.
Higher prices push the yield on bonds – annual investment returns as a percentage of the price paid – lower. Rising demand drove the yield on benchmark 10-year German government bonds below zero on June 24 2016, to a record low. When yields are negative, buyers of bonds are effectively accepting a nominal loss if they hold the bonds until they mature.
Even well-diversified portfolios cannot guarantee against paper losses during periods of market volatility, which can hit the values of traditionally uncorrelated assets. However, the price of an asset matters most when you come to sell it.
Past performance is of course no guide to future returns, but it has been common historically for investors to react disproportionately to major news. While volatile markets may be uncomfortable, long-term investors should focus on the fundamental value of assets which may not be affected by market-moving events.
The prospects of some British companies, for example, might barely be affected by the UK’s exit from the EU, but their share prices might have fallen with the broader stockmarket in the immediate wake of the referendum.
Investors focused on achieving long-term value should aim to buy assets when they judge the market price to be cheap, as they could potentially profit if asset prices recover after short-term factors recede. Even after a slump asset prices are never a one-way bet, but volatile markets inevitably throw up value opportunities for investors with long-term goals.
When you're deciding how to invest, it's important to remember that the value of investments does go up and down. So how much your investments are worth will fluctuate over time, and you may not get back the original amount you invested.
Past performance is not a guide to future performance.
Unfortunately we are not able to give financial advice and the views expressed in this article should not be taken as any kind of recommendation or forecast. If you are unsure about the suitability of your investment, speak to your financial adviser.