Brexit-Proof Your Portfolio through Industrial Investment

• Introduction

As Britain's scheduled departure from the EU draws ever closer, the prospect of a no-deal exit becomes increasingly realistic.  This would force the UK government to make significant spending cuts while in the process undermining Prime Minister Theresa May's promise to UK residents that public services such as NHS would now suffer rather than benefit from Brexit after March 29^th, 2019.

While the UK and EU financial markets remain cautious, investors have begun to review their portfolios in order to ensure that it remains profitable in the long-run. Investors are aware that how Brexit has continued to wreak havoc on the UK's economic fundamentals such as its currency. The value of pound sterling continues to slide down as the pound is currently traded within a restricted and narrow range as negotiations continue[1].

[1] The Financial Times

Figure 1: Economic Growth in the UK has Gradually Declined

When compared to other of its EU counterparts, the UK's economy has been fairly resilient. This was evident even during the peak of the Euro sovereign debt crisis when the UK was recording positive economic growth over the period of 2012-17 but failed to sustain this growth trajectory in the long-run[1] (refer figure 1). In response to the current weak growth rates, UK policymakers were then left blaming the events surrounding Brexit for the depreciation of the pound. Voters in the UK are still torn between both sides of the issue, where anywhere between 10-15% of total voters still remain undecided[2].

• UK's Economy to Remain Sluggish

[1] The Economist, October 2018
[2] Daily Telegraph, November 2018

Figure 2: Brexit Impact on the UK's Future Growth

Brexit is officially one year away but the significance it is having continues to influence global financial markets. The general consensus is that the no-deal Brexit scenario will negatively impact the UK's future growth rates (refer Figure 2 above). At the moment, financial Industry experts remain cautious while policymaker's are in a disaster prevention mode to ease the concerns of ordinary UK residents.

The arguments favouring the UK to remain as a part of the EU can't be ignored. For example, there is research that states that in the past, investment in the British financial markets had risen by 53 % to 660 million pounds (USD $974 million) in 2015 - the peak of any EU member[1].

This is clear evidence that both the UK and EU financial institutions' have mutually profited from Britain's membership in the EU - via the "passporting” system. Basically, this system enables financial entities licensed in one EU member country to trade across borders with relative ease and with hardly regulatory hassles. Thus, by removing itself from the EU, Britain may stand to lose nearly USD $5 billion in investment over the next five years[2]! 

[1]Bloomberg 
[2] The Economist, October 2017

Figure 3: UK's Labour Productivity Growth Slowing

The first possible scenario from the Brexit process will be an exodus of foreign banks operating in the UK. The choice to relocate from the UK will be on the grounds that it makes more economic sense to set-up an office in other EU member states as it more financially feasible. While another outcome of major concern would the disruption to businesses - especially within the financial industry and related sectors that can prove to be damaging to the UK economy that is already experiencing lower labour productivity growth (refer Figure 3).

Fear of Contagion Spreading to the US

Figure 4: Brexit Will Impact US Stocks and the Dollar

The expected impact from Brexit to both the UK and EU economies are predicted to be damaging and long-lasting especially within certain sectors within the economy. Though the extent of damage from Brexit to the UK economy is yet to be ascertained but experts forecast the impact to be equally devastating to both the US stocks and the value of the dollar[1] (refer Figure 4 above). The fear that the “contagion effect” from UK's financial sector spreading across the Atlantic seems to be the biggest concern among investors at the moment.

The reason to fear contagion is highly likely as historically, both the UK and the US economies are closely intertwined via commerce, finance, and trade[2]. The bad memories from the Euro debt saga have resulted in the global financial market remaining vigilant, specifically on the outcome of the upcoming Brexit vote. There reports that suggest that most US major banks and investors' alike will remain apprehensive over the next 2-years with the fear of the hidden risks faced by Britain when it leaves the EU[1].

[1] Bloomberg
[1] The Economist, October 2018
[2] CNBC.com

• Factors that Guarantee Industrial Investments As Brexit Proof

In this section, we'll look at how you can make your investment portfolio Brexit-proof by investing in hard assets such as industrial equipment that will prove to be potentially profitable while buffers your portfolio from increased market volatility following the UK's exit from the EU.

• Capital Preservation

The biggest fear among investors of impending consequences of Brexit remains that their capital invested does not evaporate with a “touch of a button”.

As a part of the hard asset family, shipping investments possess features that can be considered as "risk-free". There are no financial assets that can be considered risk-free. Thus, if capital preservation remains your primary goal, investing in heavy euipment can be an attractive alternative that provides a nice upside to your existing portfolio. An immediate challenge for investors to seek ways to preserve their capital. Investors have to first understand and identify which industry will be the hardest hit. The “rule of thumb” to guide investors is to first acknowledge that not all industries are created equal. This means that while some industries will be hit extremely hard by Brexit, others may cope relatively well. It's important that investors recognize this, particularly for those seeking a safe-haven such as hard assets to preserve your capital.

Figure 5: A Balanced Portfolio Will Ensure Capital Preservation

Through conducting industry research, investors will be at an advantage as they will be able to recognize which firms and industries are likely to see their share values increase post-Brexit while identifying those that are expected to become less valuable over time[1]. The obvious benefit will be that it ensures that you not only restructure a balanced portfolio in line with the wider economic climate but optimize your chances of capital preservation (refer to Figure 5 above).

Another concern is the possibility that inflationary pressure will “eat away” the value of your investments. The problem of inflation would likely stem from the widening US trade deficit with China. The common impact of inflation is that potentially erodes the initial capital invested. Hence, the fear of inflation has prompted investors to adopt another approach - the hard asset investment strategy[1]. This strategy is prudent and safe rather than choosing a risky investment such as stocks and derivatives are currently viewed as highly risky assets.

[1] Business Insider
[1] The Financial Times, October 2018

Thus, investing in hard assets such as industrial equipment is to create a protective shield to protect against inflationary pressure while ensuring capital preservation[1]. Nevertheless, it's crucial to understand the underlying strength of equipment investment which is tangible assets that are negatively correlated with inflation[2].

• Diversification Benefits

Diversifying your portfolio will enable investors to mitigate market risk while increasing their potential returns. An asset class to choose when diversifying one's portfolio is hard assets. For instance, if a portfolio that is over-exposed to either stocks or derivatives, will result in the asset worth far less due to inflation or merely driven by speculative behavior which is non-reflective of market value[2].

[1] CNBC.com
[2] Thomson Reuter
[1] The Financial times
[2] The Economist, July 2018

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