The votes have been cast and counted, and the people of the United Kingdom (UK) have chosen to exit the European Union (EU).
We expect this vote to have significant impact on the global economy, but it will take considerable time before the effects of ‘Brexit’ are fully felt in Australia. The most immediate ramification is likely to be political change in the UK, given the bitterness of the referendum campaigns. However, the referendum is not itself a binding decision but will need to be incorporated into an act of the British parliament. Under the terms of the Lisbon Treaty, the UK will then give formal notice to the EU, after which a two-year (extendible) negotiation will be held to decide on the actual terms and conditions of the exit.
Market volatility and investor uncertainty
In the weeks leading up to the vote, speculation caused increased market volatility, especially for assets denominated in British pounds. Some studies suggested that Brexit could cause the pound to weaken further against the Australian dollar and other currencies, perhaps by up to 20%. (As at 22 June, the pound was trading at about A$1.96, down from A$2.20 last August, according to XE.com.) This might suggest that Australian investors should avoid allocating their assets to the UK. But of course, by now, some of this effect is already priced in by the markets.
We also need to bear in mind that Brexit will have global effects, so merely moving out of UK assets might not achieve the desired result. While the short-term impact of the vote is likely to disrupt the markets, it’s less clear how significant this will be for a long-term Australian investor holding a well-diversified global portfolio.
The UK economy
One important dimension of Brexit is how it will affect the UK economy and, by extension, the incomes of UK citizens. There’s a range of estimates on how the UK economy will be affected; some are positive but the majority are negative.
Post-Brexit, the UK will lose its automatic right to the favourable trade terms that EU membership bestows. This might discourage inward flows of direct investment by overseas firms – for example, Australian companies wanting to establish a UK base to access the broader European market. There could also be a negative impact from restrictions on the number of EU citizens coming to work in Britain, something that has boosted the UK economy and tax revenues in recent years.
The argument that Brexit will increase British GDP assumes that trade with Australia and other non-EU countries could increase (even though such trading opportunities already exist under current regulations). The anti-EU camp also argued that removing excessive EU regulation could allow higher growth. But the UK is already one of the least regulated economies in the EU. What’s more, many of the existing EU regulations that have applied to UK businesses were initiated or supported by the UK government. In some cases, the British government has introduced rules over and above those that apply elsewhere in the EU.
Finally, on immigration, it will still be possible for EU citizens to work in the UK post-Brexit, but the choice of who works in Britain will now likely be in the hands of the UK government. So this could be better (from the British perspective, at least) than unrestricted access to workers of all types.
Costs of doing business
Brexit will probably mean higher costs for investors. The ability to ‘passport’ financial services has allowed Vanguard and other asset managers whose European operations are based in Britain to distribute funds into the EU cheaply and efficiently. In the absence of these passporting arrangements, asset managers might need to set up additional offices in continental Europe, and it’s likely that the cost of doing this would be passed on to the end investor.
The alternative argument is that the cost of investing in the United Kingdom could fall due to a removal of regulatory costs imposed by the European Union. Overall, the net effect is still probably to increase costs, but this is another area where the impact is not clear-cut.
Taking all these factors together, the pros and cons of Brexit for Australian investors will be affected by a wide range of factors. As ever, the best approach is to be clear on your goals, to take a long-term view and ensure that your portfolio is well diversified.
Reproduced with permission of Vanguard Investments Australia Ltd
Vanguard Investments Australia Ltd (ABN 72 072 881 086 / AFS Licence 227263) is the product issuer. We have not taken yours and your clients’ circumstances into account when preparing this material so it may not be applicable to the particular situation you are considering. You should consider your circumstances and our Product Disclosure Statement (PDS) or Prospectus before making any investment decision. You can access our PDS or Prospectus online or by calling us. This material was prepared in good faith and we accept no liability for any errors or omissions. Past performance is not an indication of future performance.
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