Category: brexit

Article 50 and Your Finances

Brexit Article 50

After nine months the UK has delivered. These words are what European Council President Donald Tusk posted on Twitter when he received Britain’s article 50 letter on Wednesday. We will not join the media in speculations whether the letter was “aggressive” or “positive”, or what particular UK and EU representatives’ reactions reveal about the upcoming negotiations. Instead we will focus on what we know and what it all means for your finances, now and going forward.

Article 50 Process

What exactly does “article 50” mean? It refers to article 50 of the Treaty on European Union (full text here), which regulates the process of voluntary withdrawal of a member state from the EU. It has been in force only since 2009 and is now being used for the first time in history.

The entire procedure specified (very vaguely) in article 50 is as follows:

  • A member state which has decided to leave the EU (as the UK did last year) must formally notify the European Council of its intention (as the UK did on Wednesday).
  • Following the notification, a withdrawal agreement will be negotiated. It will specify the conditions and exact date of withdrawal, as well as the leaving state’s future relationship with the EU.
  • The withdrawal agreement must be approved by the European Parliament and the European Council. The latter will act by qualified majority.

The Deadline: 29 March 2019

Importantly, article 50 specifies a deadline for the negotiations. If no agreement is reached within two years from the formal notification (i.e. 29 March 2019), the UK will cease to be a member of the EU without any trade and other deals in place. This would be the hardest Brexit possible, with disastrous effects which everyone wants to avoid. It is therefore extremely unlikely.

Article 50 contains a provision to extend the negotiations, subject to unanimous (possibly a very important detail) approval by the European Council.

Things to Watch

It is impossible to predict the outcome of the negotiations and effects on the economy. While the media have been speculating about the main topics and most likely sticking points for long time, new issues will almost certainly arise as the negotiations go forward.

Overall, future trade arrangements and access to the single market (as well as the cost the UK will have to pay for it) are the key questions with the greatest potential effect on the markets. Financial industry regulations and the ability to maintain London’s position as the financial capital of Europe will be another important topic.

Role of Individual Countries

One thing to keep in mind is that the UK won’t really be negotiating with one counterparty. Political situation in individual EU countries will certainly affect the tone and outcome of the negotiations. Therefore, some of the key things to watch are this year’s elections in France (first round 23 April, second round 7 May) and Germany (24 September).

That said, while big countries like Germany and France will definitely act as main drivers, it would be a mistake to underestimate the potential importance of smaller countries and their own particular interests. For instance, most East and South European countries will be concerned about the rights of their citizens living in the UK. Agriculture and fishing, heavily regulated by the EU, will be important topics for some countries; defence or EU budget contributions for others. There is also the very unique role of Ireland with its historical ties to the UK.

Not least, we should not forget those within our borders, particularly Scotland and Northern Ireland.

What It Means for Your Finances

If there is one word to sum up the entire Brexit story, it is uncertainty. There is very little we know. Even the people directly involved in the negotiations are unable to predict the result. Moreover, even if we knew the exact agreement coming out of the negotiations, the effects on the economy and the financial markets are impossible to forecast with any degree of accuracy. Brexit won’t be the only issue affecting the markets in the next months and years. Among other factors, developments in the US, China and other regions will be as important, if not more.

In light of the above, our recommendation is the same as it was immediately after the Brexit referendum: Stick with your strategy and don’t try to bet your savings on things you can’t predict. History has shown that consistent investing beats market timing in the long run.

We will of course continue to monitor the situation and provide updates when necessary.

Overcoming Home Bias: Why You Should Invest Globally

Not surprisingly, for vast majority of British investors, domestic stocks and particularly the FTSE 100 index represent a substantial portion of their portfolios – often to the extent of neglecting or completely ignoring other markets. Today we will have a closer look at this phenomenon, known as home bias, and discuss the benefits (and costs) of taking a more global approach to asset allocation, particularly in light of the uncertainties ahead.

Home Bias

The home bias, or the home bias puzzle, was first recognised in the early 1990’s. It has been observed that investors tend to over-allocate funds to their domestic market – more than what would be justified when taking a purely rational risk and return optimisation approach. Numerous research reports have been published by bank analysts and academics, examining the causes of home bias and its effects on investment performance and risk.

Costs of International Investing and Causes of Home Bias

In general, there are three groups of factors which discourage investors from investing internationally:

  • Financial, such as currency conversion costs, higher fund management fees or custody fees. The significance of these has declined (but not disappeared) in the last two decades due to technology and the rise of ETFs and other passively managed funds.
  • Administrative, such regulatory restrictions, paperwork or tax issues.
  • Psychological. For instance, for someone living in the UK it makes more sense to invest in shares of familiar companies like Tesco or Marks & Spencer, rather than their foreign counterparts. Being able to see actual products or stores behind a stock symbol helps with trust and comfort – essential ingredients of the psychology of investing.

Benefits of International Investing.

If your portfolio only contains a negligible portion of international equities, or even worse, if you have all your funds in the FTSE 100, your risk and return profile is far from efficient. It is very likely that in the long run you will see lower performance and higher volatility than you otherwise would with a portfolio containing just a bit more of international equities. Of course, the actual future performance of equity markets in individual countries is impossible to predict, but it is the probabilities and the outcomes across a wide range of possible scenarios which must be considered. In one word, diversification.

Geographical, Sectoral and Idiosyncratic Diversification

One argument against international investing is that shares in the domestically listed corporations already provide sufficient exposure to economic developments in other regions, as many of these companies trade worldwide. The FTSE 100 is a good example, as 77% of its constituents’ revenues come from outside the UK.

That being said, the FTSE 100 lacks sufficient exposure to important parts of the global economy which you may not want to ignore. It is traditionally heavy in consumer staples and energy, but severely underweight in the technology sector. If your portfolio mimics the FTSE 100, you have over 8% of your funds invested in a single energy company (Royal Dutch Shell), but you completely lack exposure to companies such as Google, Apple or Amazon, for instance. These are at least as important to the global economy, and to the British economy too.

How Much Is Enough?

According to a recent report by Vanguard, which refers to the latest available (31/12/2014) IMF statistics, British investors hold 26.3% of their equity investments in domestic stocks – on average. In line with the home bias theory, this is much higher than the UK’s share on global market cap (7.2%) or GDP (4% nominal / 2.5% by PPP).

Does this mean you should only have 7% or 4% of your portfolio in British equities? Of course not. After all, if you live in the UK and your general interests, liabilities and future expenditures are in this country, there is nothing wrong with British assets representing a significant portion of your investments. The exact optimum weight of foreign equities is subject to personal circumstances, such as your income, other assets and liabilities. For instance, the property you own represents substantial exposure to the future well-being of the British economy, justifying a higher share of foreign equities.

Does Brexit Change Anything?

The Brexit uncertainty does not enter the equation, unless you personally have a strong opinion regarding the future development and want to gamble on that. If you don’t, remember that in line with the Efficient Market Theory, the stock prices (and the pound’s exchange rate) are already reflecting the market’s consensus and thereby all the currently available information.

In the long run and under the “hard Brexit” scenario, looser economic ties with Europe might result in a decrease in correlation between the UK and EU in terms of economic and stock market performance, increasing the diversification potential of European equities. However, this effect will most likely be marginal, if any.