A Rock and a Hard Place
In every way, the events of October 2019 were the perfect storm for investors whose base currency is the British Pound. The UK represents less than 5% of global GDP and its population is a mere 1% versus the rest of the world. For most global investors, that means that a relatively small amount of capital is hence allocated to Sterling based assets. Whether you live in Singapore or in France, the world is still the world and as such to be regionally diversified means you buy it in the same tranches. Therefore, also for investors in the UK, you would have a large part of your portfolio in US Dollars, Euros and Yen.
How much? Well, that’s the difficult question and here’s why: Let’s say 10% of your money is in Sterling and 90% in all the other currencies as part of your globally diversified investment strategy. What happens if Sterling goes down? Then you have made money in all the other currencies and when you convert those into the weaker Pound, you have more than you had before. But what about if Sterling goes up? Then you would lose on 90% of your portfolio. In other words, if there was such an event, such as a soft Brexit and Sterling were to re-trace some of the 20% it lost against all the other currencies after the referendum, it could result in huge losses.
On Tuesday, October the 8th, Sterling was trading at 1.22 versus the US Dollar. On Friday, October the 16th, it traded at 1.30, for a gain of 6.5%. Sticking to our example, this means Sterling based investors lost 5.85% of their money in those 8 days (if you take the US Dollar as a proxy for all the other currencies). These were the realities for which one had to prepare, and there is nothing more tortuous than watching politicians argue about the same issues over and over again, whilst the consequences of their actions are very clear. This is both the beauty and cruelty of investing in the world’s financial markets. It’s all about the numbers, there is no right or wrong answer, there is only either making or losing money.
Clearly, potentially losing so much of one’s money on a totally binary outcome is too big a risk to bear for most. And I note, that as of the writing of this post, there still does not seem to be any clarity on Brexit, soft, hard, or not. So, the only sensible thing to do is to hedge. Buying insurance, in the form of forwards or (OTM) call options on Sterling, would cost less than 1% in premium. Money well spent, if you didn’t want to risk potentially losing more than 20 times that much, in case it goes all the other way. Wonder how many of the UK based businesses who export 46% of all goods to the EU have prepared for these events and uncertainties?