[The following "ETF Industry Perspective" is sponsored by IndexIQ]
On June 23, the voters of the United Kingdom went to the polls and decided to leave the European Union, by a margin of 52% to 48%. Markets adjusted Friday morning with the Nikkei Index -8%, FTSE Index -4%, CAC 40 -6%, and the DAX -7%.1 In currencies, the British pound recorded a 31-year low against the U.S. dollar, while the Japanese yen strengthened. Ten-year U.S. Treasury yields have fallen to 1.54% on a flight to safety. Some further market volatility can be expected as the process unfolds.
UK Prime Minister David Cameron has resigned and the British Cabinet will begin to work out next steps on Monday. The Bank of England has pledged to be supportive and will take measures as required to promote financial stability. The bank said it has stress-tested scenarios more severe than the current challenge.
The UK will remain in the European Union for another two years according to Article 50 of the Lisbon Treaty. During this period, planning and negotiations involving trade and other matters will take place.
Here are some key investment takeaways:
- Since the markets can be unpredictable, it remains important to construct your portfolio to withstand multiple scenarios. Therefore, diversification continues to play a vital role as evidenced by Figure 1, which reflects the average asset allocation used by the top 40 U.S. wealth managers. As you can see, ample allocations have been made to stocks, bonds and other asset classes that are not always correlated to one another. Please see our recent report for a framework on blending active and passive strategies.
- Currencies can be hard to predict. In the 30-, 60- and 90 days leading up to the Brexit vote, the British pound appreciated and depreciated approximately 50% of the trading days against the euro and U.S. dollar. The same can be said for the euro against the U.S. dollar. For many, we believe a 50% currency hedge on international equity exposures represents a thoughtful way to manage these ups and downs.
- Central banks remain supportive. We expect monetary policy makers to value stability in light of recent events. Indeed, the Swiss Central Bank has already intervened in the foreign exchange market after the Brexit vote.