Monday 27 June 2016 by Opinion

Brexit and benefits of a diversified portfolio

“It finally happened
It finally happened, oh yes
It finally happened
I'm slightly mad!
Just very slightly mad!
And there you have it!”
I’m Going Slightly Mad, Queen (1991)

I have no idea about what the real Queen, Queen Elizabeth II’s mindset is, but David Cameron has not only failed in his poorly conceived attempt to unite the Conservative party, but also carries the unprecedented shame of being the UK Prime Minister who primed and then ignited the disintegration of the United Kingdom as we know it.  Well done Dave! At least he had the decency to fall on his own petard, abruptly resigning on Friday morning and leaving someone else to pick up his widely scattered shrapnel.

After the events of the last few days, it is difficult to see the simple path out of this situation, which could hardly have come at a worse point for the UK and more broadly the world economy – already hanging by its finger tips onto an incredibly low growth trajectory.  Will the resulting uncertainty be enough to tip the world in to recession? 

This stunning outcome – and let’s make no bones about it, this referendum result shocked and stunned financial markets – will have repercussions far beyond Kent’s white cliffs of Dover.  There are many that think this could be the beginning of the end for the European project known as the single currency, which will eventually fail.  There can be no monetary union without fiscal union.

Furthermore and more urgently, what does this mean for the US election? Should we be expecting the unexpected? I think the Brexit vote confirms the shift to the right in western politics; with a more nationalistic, populist and anti-establishment sentient talking a firm grip in many countries.

Bringing this back to financial markets; after the tumultuous and historic decision on Friday that saw the UK vote to leave the European Union (EU), there was plenty of volatility in all asset classes with some precipitous falls in equities.

On Friday:

  • the ASX200 closed down 3.2%
  • the Hang Seng lost 2.9%
  • the Nikkei dropped 7.9%
  • the Dow was off 3.4%
  • S&P500 -3.6%
  • NASDAQ -4.3% 

It was worse in Europe:

  • the CAC 40 plunged 8.0%
  • DAX -6.8%
  • FTSE100 -3.2%
  • Athens General -15.9%
  • Italy’s MIB -12.5%
  • Spain’s IBEX35 -12.3%
  • Portugal’s PSI20 -7.0%

As you would expect safe haven assets performed well; on Friday, 10yr UST bond prices increased 1.7% and 10yr Australian government bonds gained 2.0%. If you had an allocation to government bonds it would have partially offset equity losses.

With hindsight it is easy to pick the outperformers, but what events like these should starkly highlight to investors is that diversification of portfolios and asset allocation is critical.  It is paramount that you are comfortable with the risks and potential losses that you take and their commensurate returns.

Unfortunately given Australian investors’ irrational bias towards equities, when the markets are in freefall, they tend to be whacked the hardest.  In the rest of the world where the term ‘balanced portfolio’ is not an oxymoron, investors have a better chance of withstanding these violent swings with substantially reduced losses.

I can talk about this until I am blue in the face but investors seem to only take action after the fact.  But as the saying goes, “better late than never”, so don’t follow Dave and fall on your own petard – make sure your portfolios have the correct weighting to fixed income, which is likely to be considerably higher than it is now.