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The Bank of England is feeling more optimistic about the future — but are you?
Thursday’s decision to raise interest rates for the second time in a decade was a decisive move from the central bank’s rate-setting Monetary Policy Committee, whose members voted unanimously to raise rates by a quarter point.
However, the same unity cannot be found among UK politicians. They have spent the summer in knots over Brexit negotiations, unable to agree the way forward between themselves, let alone with their EU counterparts. Amid fears that Britain could crash out of the bloc without a formal deal next March, what could this mean for your finances?
We asked advisers and industry experts how they are preparing for a potential “no deal” Brexit, highlighting key areas of concern for investments, property and pensions, and what financial planning measures are being considered.
Sound as a pound
Experts agree that sterling will suffer if Britain exits the EU without a deal. Last month, amid disappointing economic figures and fears of an acrimonious exit from the union grew, the pound fell briefly below $1.30.
Sterling rose immediately after the BoE announced its decision, but the gains vanished as governor Mark Carney implied caution on further UK rate rises.
In the event of “no deal” and a sharp fall in sterling, Ben Seagar-Scott, chief investment strategist at wealth manager Tilney, says it would be hard to predict how the Bank of England would react.
“In theory, it would be pushed in two opposite directions — on the one hand to increase interest rates in order to defend the currency and avoid a spike in inflation, but on the other to loosen monetary policy and inject fresh stimulus into the economy.”
The UK’s reliance on imported goods means a failure to thrash out trade agreements risks an inflationary surge in consumer prices.
“This could have a knock-on effect on the performance of listed housebuilders, retailers that are already feeling the pinch of structural change and those that sell ‘big-ticket’ items such as cars or sofas may be hit more as UK citizens spend less amid the uncertainty,” says Darius McDermott, managing director at Chelsea Financial Planning. “Likewise, holiday companies and airlines could be impacted as it will become more expensive for us to go abroad.”
However, investors holding companies which generate the majority of their income overseas stand to import the dividend benefits if sterling weakens, says Mr Seagar-Scott.
The UK’s blue-chip FTSE 100 index performed strongly in the wake of the 2016 referendum, as the average constituent generates around 70 per cent of its earnings in a currency other than sterling. However, domestically focused companies in the smaller FTSE 250 index are more vulnerable to shocks in the UK economy — around half of the mid-cap index’s earnings are generated in the UK.
Ben Willis, head of portfolio management at Chase de Vere, says oil and gas companies — which make their profits in US dollars — could do particularly well, but that a cheap FTSE 100 index fund would be a sensible way to hedge against weakened sterling.
Shifting investment focus
Wealth managers say that fears of future sterling weakness are already weighing on UK investors’ minds. However, clients are concerned about the wider climate of political uncertainty, rather than the specific threat of a “no deal” Brexit.
“Clients are mostly trying to fathom what it might mean for their portfolios, and seeking some reassurance, although it is undoubtedly driving some risk aversion, especially towards sterling assets,” says Jason Hollands, managing director at Tilney Group.
“Alongside this, there are parallel concerns about the fragility of the UK government and the potential for a snap election and a Corbyn-led Labour government [coming to power] — which for some clients is a greater fear.”
Advisers report that some investors are considering cashing out part of their portfolio or reducing their exposure to UK equities to insulate themselves from the effects of a hard Brexit. Many want to hold more dollar-denominated assets or perceived safe haven assets, such as gold.
“Customers are worried about having too much in the UK market and having too much in sterling,” says Peter Lowman, chief investment officer at Investment Quorum, a wealth manager. “People feel that without the trade agreements in place and no relationship with Europe, the UK economy could suffer and companies will suffer in terms of profit.”
Spooked investors also want to buy gold, currencies such as the Swiss franc, Japanese yen and US dollar — and even US government bonds. “Those are the assets people rush into as defensive assets and are the things that people are asking about now,” he adds.
Other advisers say clients are debating whether to hold more cash to protect themselves.
“Clients are worried about the uncertainty — they feel out of control,” says Sophie Kilvert, relationship manager at Seven Investment Management, who says many are asking about moving into cash as a result. However, she is urging them to look at the long-term picture.
“For clients who know they will need money between now and March next year, they might want to hold cash as a safety net,” she says. Otherwise, most managers agree that clients with globally facing, diversified portfolios will be well insulated in the case of a no-deal Brexit, and are even likely to benefit from the weak pound in the short term at least.
“Having international assets which will appreciate in value as sterling slides is a way to benefit and protect yourself [through a no-deal Brexit],” says Richard Champion, deputy chief investment officer at Canaccord Genuity Wealth Management.
Killik & Co, a wealth manager, stresses that the Brexit vote has so far been good for the performance of clients’ assets, due to currency moves and the strong performance of global stock markets over the past two years.
“Clients are surprised to hear that the Brexit vote has up until now been good for their performance but it is because portfolios have benefited from foreign currency exposure,” says Michael Pate, a Killik & Co partner.
However, global markets come with risks too, meaning a diverse mix of assets is key. Global markets have been pulled upwards in recent months by the strong performance of US equities, particularly tech titans such as Amazon. However, others such as Facebook and Twitter have suffered large falls in the past few weeks as investors have grown nervous about their ability to keep growing.
“The US stock market particularly is expensive at the moment and technology particularly has weakened in recent months,” says Mr Lowman.
As a result, more contrarian managers are seeking areas of better value — and some say there is no need to abandon UK equities. Large-cap UK stocks are less affected by domestic policies than smaller UK companies. Some wealth managers favour the banking sector, which stands to benefit from rising interest rates, and could bounce back if the UK is able to wrestle a deal with Brussels that would insulate financial services.
Yet overall, many wealth managers are still “underweight” on the UK. Investment Quorum has reduced the UK assets in its balanced portfolios to 25 per cent, down from about 35 per cent a decade ago.
US government bonds have also been added to client portfolios at 7IM for their “safe haven capacity that can work in times of fear”, as well as the “advantage of having some dollar exposure”. The investment manager has not been buying UK government bonds, which are vulnerable to rising interest rates in the UK.
Several FT Money readers have contacted us to ask if buying the US share classes of funds and shares could combat the effect of currency on their investment returns. However, experts caution that this could be a costly mistake.
The only currency that matters when buying a fund is the underlying currency of its assets, not the currency the fund is listed in. Buying a foreign share class will not affect your returns, and you will pay more for it too — brokers will charge you to convert dollars back to sterling, adding an unnecessary charge to your portfolio.
Fund analysts say a more helpful way to think about currency in investing terms is to consider buying stocks with overseas earnings. Assuming the pound is weak, the returns would be flattered when converting into sterling. In contrast, the exchange rate between the currency your fund units are quoted in and your domestic currency is irrelevant.
There are a small group of funds that do strip out the impact of currency, known as currency hedged funds. These use financial instruments to neutralise the effect of currency movements between the assets investors buy and their domestic currency, and are a very different proposition.
“It’s important to distinguish between the very small number of funds that have a currency hedging strategy and the more commonly available versions of funds that offered multiple share classes priced in pounds, dollars or euros,” says Mr Hollands at Tilney Group. “I can’t see any reason why a UK buyer would chose non-sterling share classes.”
Investment performance is not the only concern in the event of a “no deal” Brexit. Investors in funds could face reduced choice and potentially higher fees due to the end of so-called passporting arrangements that exist between the UK and EU countries. In a worst-case scenario, some asset managers could pull their funds from UK platforms — although many in the industry feel such a scenario is unlikely.
Most European funds currently operate under guidelines known as Ucits (undertakings for the collective investments in transferable securities). Funds meeting Ucits criteria can be sold to investors anywhere in the EU regardless of where the asset manager is based, which means it is easy for UK investors to buy European funds and easy for European investors to buy funds based in the UK. If no deal on financial services is reached, passporting arrangements will end when the UK quits the bloc.
Currently, a large volume of Ucits funds sold to UK investors are domiciled in Dublin or Luxembourg. As a contingency plan, asset managers wanting to sell those funds to UK investors could set up “mirror” versions of those funds and list them in London.
However, such funds would come with additional costs to the fund company and be much smaller than the original versions — meaning the cost to investors is likely to be higher too, at least in the short term. In the worst-case scenario, some companies may choose not to bother listing in London at all.
“Managers don’t really want to operate mirror funds,” says Nish Dissanayake, partner at law firm Herbert Smith Freehills, who advises asset managers on regulatory issues. “At the moment, investors have access to everything. It is not a given that fund houses will replicate all of their funds for UK investors.”
Larger fund houses are considered more likely to absorb such costs. Given the current pressure to bear down on fees, managers would likely do everything they could to keep fund costs low.
In a recent PwC survey of more than 70 senior asset and wealth managers, almost half (45 per cent) of respondents had not relocated investment management functions, but more than a fifth said they planned to do so.
The end of passporting arrangements could also prevent private pension companies in the UK from paying pensions to millions of retired expats living in the EU, according to the Association of British Insurers.
“A no-deal situation would leave insurance contracts in a legal limbo, where insurers would be unclear if they could legally pay claims for contracts that have been written pre-Brexit, which would have to be paid out in countries in the European Union,” says Huw Evans, director-general of the ABI, which is calling for the issue to be urgently addressed.
Speaking at a hearing of the Exiting the European Union committee, Mr Evans said there was a “perfectly plausible” risk that some British pensioners living in EU countries post-Brexit might not receive their pensions, if the issue was not resolved.
Experts have identified an expensive though long-winded solution. Life companies could, in theory, set up an EU subsidiary, and transfer the pension policies there to be paid out from an EU entity. Some firms are already doing this, but others are waiting to see if any other form of solution can be brokered.
There is also uncertainty over state pension arrangements for expats post Brexit. Currently, the UK state pension is payable overseas but annual inflation rises are only applied to the pension if the pensioner is in an EEA country or one with which the UK has a reciprocal agreement requiring uprating.
The rules post-Brexit will depend on the outcome of negotiations. However, the government’s July 2018 white paper said the UK would seek reciprocal arrangements, which “could cover provisions for the uprating of state pensions”.
One of the potential ramifications of a no-deal Brexit is that it triggers an economic shock in the UK, leading to a recession and higher unemployment. Under such a scenario, the housing market might be expected to go into retreat.
However, some experts argue that levels of political uncertainty have already been so high that this risk is already priced into the market. Ray Boulger, senior technical manager at mortgage broker John Charcol, says the speculative or investment buyer has already gone into abeyance as house prices rises have slowed and regulation has weighed on buy-to-let. The remaining buyers and sellers have reasons for moving that will not be affected by Brexit.
“As far as the average UK citizen goes, it’s not going to make an awful lot of difference to when they move,” he says. “People move because of personal reasons, job change, divorce and so on. In terms of both the speculative and investment buyer, transactions have already fallen, so I’m not sure they will fall much further.”
Crashing out of the EU might have a knock-on benefit for mortgage borrowers, he adds, since it would discourage the Bank of England from raising base rates. “So the cost of acquiring a property will remain low, as will monthly mortgage payments.”
Some parts of the UK housing market may be more sharply affected than others. The top end of the London market has weakened significantly over the past three years, with prices falling and transactions down as the wealthy overseas buyers who boosted prices during the euro crisis dropped away in the face of Brexit uncertainty. Should sterling fall after a no-deal scenario, overseas buyers may be attracted back to the capital by any discounts relative to their home currency.
Conversely, UK residents considering an overseas property purchase may find currencies shifting against them, both in purchase prices and monthly repayments on foreign currency mortgages.
Fiona Watts, co-founder and managing director of International Private Finance, which brokers mortgages for UK borrowers on overseas properties, says the uncertainty that weighed on the market at the time of the referendum in 2016 has returned in recent months amid talk of a no-deal scenario.
Ms Watts says clients most frequently ask about potential changes to their right to stay in or visit an EU country in which they buy; their access to healthcare there; the country’s pension agreement with the UK; and changes to rules on taxation once the UK has left the EU.
This will be of less concern for those seeking to buy an investment property. Those looking to retire abroad — around a quarter of her clients — are much more vulnerable to the imponderables of Brexit.
“If they’ve been planning this for 10 to 15 years and putting down money for a deposit, they are nervous and rightly so,” she says. “Those things have a huge impact.”
Is next year’s European holiday in doubt?
Travellers planning on taking a European holiday after “Brexit day” on March 29 next year could find it costs a lot more than they bargained for in the event of a “no deal” Brexit.
Any adverse sterling movement would push up the cost of foreign currency. To an extent, this can be mitigated by planning ahead — but travel disruption is harder to plan around.
“There have been concerns that a ‘no deal’ Brexit could lead to planes being grounded as there would be no agreement in place for travel between the UK and the EU,” said Carolina Vicente, travel expert at insurer Columbus Direct, referring to the EU Open Skies agreement.
Budget airline Ryanair has repeatedly warned about potential disruption and cancellation of “flights and routes” from April 2019 onwards if there is “not sufficient time or goodwill on both sides to negotiate a timely replacement”.
At present, passengers on delayed or cancelled flights can claim compensation from airlines via EU laws. However, passengers are not entitled to compensation if the disruption is due to “extraordinary circumstances” that are beyond an airline’s control.
Travel companies have been taking the risks seriously enough to start to write clauses into their booking conditions making clear that the company would have responsibility only for the reimbursement of the service the customer has purchased.
“Make sure you check the terms and conditions of any bookings you make ahead of the Brexit date,” says Ms Vicente. “In the unlikely event planes are grounded, this will have little impact on [refunds for] customers who have booked package holidays. But those buying flights and accommodation separately could find themselves with non-refundable accommodation costs and no flight to get them there.” She cautions that this is not something that most travel insurance policies would cover either.
The ability of UK travellers to rely on the European Health Insurance Card (Ehic) for emergency medical treatment in the EU is also uncertain. This could push up the cost of travel insurance, especially for people with existing health conditions.
“We’re all still waiting to discover the fate of the Ehic and what, if any, reciprocal health agreements we will have in place in the future,” Ms Vicente adds. “With no reciprocal agreement in place, the medical costs incurred if injured abroad would increase, so the cost of insurance cover for travel to Europe would be likely to do the same.”
One issue that has been resolved is that of hire car insurance. It was confirmed in May that British drivers will be able to use their existing insurance policies when travelling in Europe after Brexit.
The UK will remain inside the “free circulation zone” after it leaves the EU, meaning drivers will be able to continue to use their existing insurance policies in the EU27 plus Serbia, Switzerland and Andorra.
With Easter falling so late next year, many British families may opt to play it safe and book a “staycation” rather than risk travelling abroad in mid April. On the one hand, increased demand could push up the price of a UK break. On the other, if the “no-deal Brexit” travel disruption fears are overdone, canny holiday bookers could snap up a good deal on a European holiday.
Reporting by Kate Beioley, Aime Williams, Lucy Warwick-Ching, James Pickford and Josephine Cumbo