The British pound has been on a wild ride ever since the EU referendum in 2016, and recent months have only exacerbated these swings as the country teeters on the edge of a potentially disastrous no-deal divorce from the European Union.
Since the Brexit vote, the British currency has fallen 16% against the US dollar, and now most experts agree that sterling is fundamentally undervalued, with many seeing the possibility of a 10 to 20% rally.
However, opinions are divided on how the pound could react in a no-deal scenario. Craig Erlam, senior market analyst at Oanda, says: “A lot of no-deal risk has been priced in over the last few years but that doesn’t mean it won’t get worse for the pound in the event of no-deal. Many people are forecasting another significant decline but with so many factors up in the air, it’s all guess-work at this point.”
Graham Neilson, investment director at Fulcrum Asset Management, agrees that much of the Brexit risk has been priced into sterling, adding that “in the event of no-deal, [he does] not see anything as radical as after the EU referendum”, when the currency plummeted to a 31-year low in one day.
But Chris Peel, chief investment officer at Tavistock Wealth, is of the firm opinion that sterling could rally stronger in the event of a no-deal than if a soft Brexit agreement is reached. “If Trump makes a trade deal with the UK, he will not want sterling at $1.20,” he says. “He will want a currency at purchasing power parity, so I could see sterling going back to $1.45 quicker than in a soft Brexit scenario.”
Cautious Positioning
When it comes to the question of hedging, the answer is as complicated as the Brexit negotiations themselves. Many investors believe making a bet that sterling will move either way is too much of a gamble and prefer to err on the side of caution.
Ben Yearsley, director at Shore Financial Planning, says investors must weigh the cost of hedging against the potential losses they could suffer from downward moves in the pound. However like many others, he sees potential for upside, which could hurt those with sterling hedges.
“If we do get some form of Brexit clarity then you could see the pound shoot up maybe 10% or 20% - that would be quite painful for portfolio values,” he says.
Tom Clarke, portfolio manager of the dynamic diversified allocation strategy at William Blair, says that although the pound has been attractive on valuation grounds since the second half of 2016, he has “neutralised what was previously a long exposure to sterling due to the risks posed by Brexit”.
He explains: “The possibility of a successful withdrawal agreement reached with the EU (and approved by the UK Parliament) still exists, but is a relatively low probability at this point, hence we see the near-term risks to the pound as mostly negative,” he says.
Alessandro Marolda, senior consultant at Dynamic Solutions, is also reticent to advocate an “outright hedge or short” of sterling, given its large falls to date. “Rather, a possible suggestion is to leave global equities unhedged (with perhaps some other investments) in order to diversify the currency mix in investors' portfolios,” he says.
For Fulcrum’s Neilson, the heightened risk of a no-deal Brexit has led to trading sterling more actively in the discretionary portfolio: “When volatility has been high we have tended to sell it, primarily because when the risk of no-deal rises people hedge sterling, so volatility tends to rise.”
Contrarian View
But not everyone is so cautious – for some more contrarian-minded investors, the opportunity is too good to miss. Steven Jon Kaplan, chief executive at New York-based True Contrarian Investments, sees the current overall negative sentiment towards the pound as a chance to increase positions versus the US dollar.
“There has been a lot of talk about Brexit but hardly anyone has examined how the weak British pound has affected the UK economy,” he says. “Since wages are paid in British pounds while products and services are sold at the same world prices in US dollars, profit margins have significantly improved. Eventually investors will realise that the fundamentals demand a much higher British pound.”
David Coombs, head of multi-asset investments at Rathbones, also believes the risks for sterling are on the upside and has therefore hedged a large proportion of the foreign currency exposure across his funds.
“We think running big overseas weightings is a risky thing to do if there is a breakthrough on Brexit and sterling rallies strongly,” he says. “But it is way below fair value, which means it could snap back sharply if we were suddenly to get a deal.”
However, Coombs is mitigating the risk of leaving sterling exposure unhedged by avoiding UK-facing companies and focusing on overseas earners, which benefit from sterling weakness.
