Scottish Independence: Whether It’s Yes Or No, It Does Affect You

Returning home to Edinburgh last week for the Fringe, I only had to join the taxi rank outside the rail station before I overheard the first conversation about the looming referendum on Scottish independence.

“It would be a shame, such a shame,” grumbled an Englishman.

“I have lots of English friends and they are fully supportive of us, they say just go for it,” one Scottish girl huffed in response.

That seems to sum up the attitude at the moment – the more Scottish residents are told they cannae, the more they are tempted to vote Yes.

But there is an even more important issue for investors – what happens to all the money?

We are not far away from the referendum on 18 September. Whether it piques your interest or not, it surely will have an effect on your investments.

As Alex Salmond and Alistair Darling fought it out on national television last week, the papers claimed it went in Darling’s favour. Going independent is like a divorce, he said, and if you want a slice of the currency, the other person has to agree to it.

There are other uncertainties, as outlined in “The Scotsie Index: 60 Years Of Scottish Stocks”, a report put together by Paul Marsh from London Business School and Scott Evans of Walbrook Economics. It read:

“The issues that are likely to have the greatest impact on the business sector are the questions of currency, corporate and personal taxation, double taxation treaties, EU membership, employment and business law, pension arrangements, immigration policy, Scotland’s credit rating and the impact of a (likely) lower rating than for the UK on borrowing costs, whether there would be a Scottish Central Bank, and the regime and institutions required for business and financial regulation.”

Just a few basics, really.

So what would a Scotsie 100 ETF look like? You would be highly concentrated in a market cap index with just over one third in RBS, SSE and Standard Life alone, and well over 50 percent in financials. Then again, it wouldn’t be as concentrated as many other European countries like the Czech Republic and Ireland.

Now, it comes to returns. If you had invested £1 in the Scotsie in 1955, you would have made £648 in 60 years. You would have almost doubled your returns - £1168 – if you had invested in the rest of the UK. Although the two indexes were almost identical for much of the time, Scotland’s heavy reliance on financials HBOS and RBS brought about its downfall after 2008. The standard deviation and volatility of Scotsie returns were also higher during this time, albeit by a small margin.

What stands out in the Scotsie is that there are ten investment trusts in the top 20 companies - pooled vehicles that also trade on exchange like ETFs – and the largest is Scottish Mortgage Investment, run by James Anderson, with a free float market cap of £2.6 billion. Another is Edinburgh Investment Trust, which Neil Woodford used to manage.

Things have certainly changed in sixty years. There used to be four stock exchanges in Scotland, although London was always the main trading centre. Assuming Scotsie stocks all switched their listings to north of the border and we created our own exchange, Scotland would become the 14^th largest market in Europe.

So how would the indexers deal with this situation?

Scottish stocks would then be classed as “foreign”, and be required to have a 50 percent, instead of 25 percent, free float, to be eligible for the FTSE UK Index Series.

FTSE states, as a general rule of thumb, that a company’s nationality is the country where it is both incorporated and listed. But this rule can’t apply here, as currently the United Kingdom is one country.

Neither can you base the decision on a company’s customer base or on its assets. Glasgow-based engineers Weir Group generates just 4.3 percent of its revenue in the UK. What about the shareholder group? What about the company’s head office and registration?

FTSE, S&P and MSCI all declined to comment, but S&P’s index committee chairman David Blitzer said that even if a vote passes, a Scottish exchange is some years away and most companies will keep their current listing, just as some US companies are incorporated outside the US. It seems that indexers are playing the game of wait and see – much like everyone else.

In the meantime, Marsh and Evans do not recommend that investors need to start rebalancing their portfolios or divesting from Scotsie stocks. All we can do is enjoy the Fringe festival and our returns while they last, and maybe leave the heated debates for the taxi rank.