Hedging a Brexit

The Washington Post recently outlined four possible outcomes of a Brexit, or British exit from the European Union. Barring the assassination of another British politician, campaigning is expected to resume this weekend and a vote is to take place next week on June 23rd. As the initial article states, an exit for Britain will result in further negotiations over its relationship with the EU (as well as non-EU countries), referred to by the author as the “terms of divorce”. Ahhh, parting is such sweet sorrow. A Brexit raises many questions. How will trade function? How will market volatility be affected? How will currencies fluctuate? What will happen with the EU citizens living in Britain and the British citizens living in the EU? How will specific areas currently under the authority of the EU, such as agricultural policies, be impacted? Currently there are no answers or plans, only models to feed off, and none of them paint an ideal future. So, how to hedge a Brexit? In the face of uncertainty and volatility, below are three ways one can attempt to hedge a British exit from the EU.

By most accounts, Britain will be inflicting financial (and other) pain on itself by voting to exit from the EU for reasons that seem largely centered around the issue of immigration, which is a burning hot (perhaps even scalding) issue in many, many developed nations. At risk is Britain’s ability to trade easily with what is known as “The Single Market”, or the integrated European economy that was created by striking down barriers between EU member states. This Single Market is effectively Britain’s largest trading partner. Damaging the UK’s ability to trade hurts its economy, industries (especially its services industry) and its currency, and will hurt others as well. Central banks around the world are already hinting that they will take whatever actions are necessary to stabilize currency and other markets, for instance. So, how to hedge?

Gold

The yellow metal had jumped solidly above $1,300 prior to the publication of this post before the aforementioned British politician was assassinated and it dipped back below $1,300. Many would argue that it was rising because of a Brexit and fell because the assassination delayed campaigning in the UK on the issue. That may or may not be the “real” story, but it is true that when central banks look nervous and currencies look dangerous, i.e. the pound might fall as well might the euro, or there may be central bank currency intervention to stabilize currency markets, gold supporters tend to argue that gold is the ideal place to be. While we have previously mentioned why gold isn’t all it’s cracked up to be, including that it is a largely psychological asset, that doesn’t change the fact that people may rush into it as a safe-haven asset. It seems primed to jump on Brexit “yes”.

Treasury Bonds

Crisis after crisis, investors have shown their love for the safe-haven asset that US Treasuries constitute, and this will continue. US government debt is still safer than the alternatives, especially as European bonds are rumored to take a hit if a Brexit should occur. A long position in a US Treasuries index fund like Vanguard’s BND is something that should be a part of a well-balanced and diverse portfolio, anyway.

Currencies

We anticipate that the British pound will suffer, at least at first. The riskiest thing to do would be to take a direct contrary position to the pound by shorting an instrument like the ETF FXB. Indirectly, one could invest in the Japanese Yen by going long the ETF FXY. The Yen has already appreciated greatly in anticipation of a Brexit as the Yen has also long been seen as a safe-haven asset. Or, given that people tend to pile into Treasury bonds in times of trouble, the US dollar is a more-than-viable option, and one can go long utilizing the ETF UUP.

In the end, one remains best off with a well-rounded, balanced and diversified lazy portfolio. One should only consider one-sided investments in the above if their cash is burning a hole in their pockets.