THE FALLOUT
On 24 June, the day after the referendum, the FTSE 100 took a battering, shedding 8% (£120bn) in its biggest opening slump since the financial crisis. But it rebounded to a 10-month high on 1 July, hitting its best level (6,577.83) since the previous August – a 7.2% increase between 27 June and 1 July. Meanwhile, on 6 July the pound plunged to its lowest level against the dollar in 31 years, bottoming out at $1.28, while UK gilts plummeted below 1% to 0.8% for the first time in history. Two ratings agencies – Standard and Poors and Fitch – downgraded UK government debt.
The Bank of England (BoE) governor Mark Carney immediately tried to quell fears of a meltdown, saying the Bank had been “well prepared” for a leave vote. However, the bank’s subsequent financial stability report on 5 July said Brexit risks had “begun to crystallise” and described the current outlook for UK financial stability as “challenging”. As a result, the BoE eased the capital control rules on UK banks to encourage additional lending to the tune of £150bn. The bank also lowered rates by a further 25bps on 4 August, their lowest level in its 322-year history.
CONTAGION
As Ruth van de Belt, an investment strategist at Kempen Capital Management, points out, the dissatisfaction among voters that led to Brexit is not just a UK or European phenomenon; the US is also growing support for anti-establishment parties on both sides of the political spectrum.
“We do not believe that this dissatisfaction will dissipate quickly,” she says. “Given the large number of political events scheduled for the coming 18 months, we anticipate that political uncertainty will remain high.”
Van de Belt believes increasing political fragmentation is making it more difficult to form stable government coalitions creating, what she terms, a “high risk of a risk-off sentiment flaring up prior to important referenda and elections”.
FLIGHT TO SAFETY
In the short term, volatility has hit UK pension funds hard, particularly when it comes to deficits. Following Brexit, panicked investors piled into gilts which pushed yields down and liabilities up.
According to Hymans Robertson, UK pension scheme liabilities hit an all-time high of £2.3trn on the Monday following the referendum result – the worst it has been by about £25bn. Meanwhile, figures from Mercer reveal FTSE 350 deficits hit a record £119bn in June, driven by a fall in both government and corporate bond yields.
“Some investors are effectively forced into buying gilts because of the way financial regulations work,” says Hymans Robertson partner, Patrick Bloomfield. “Perversely, higher gilt prices could increase demand for them, pushing gilt prices higher still and potentially sending pension liabilities further north.”
Punter Southall Investment Consulting believes that in the post-Brexit environment schemes should ideally hedge 100% of interest and inflation risk – or 50% as an absolute minimum. “Anything lower is deemed to be a bold bet on markets and leaves a scheme exposed to the potential for interest rate and inflation rate risks to be the dominant source of volatility within the portfolio,” it says.
