Five ways to ride out EU referendum

It is no secret that investors hate uncertainty. And there is no bigger uncertainty, as far as UK investors are concerned, than the upcoming European Union (EU) referendum. The latest polls suggest that the vote on EU membership on 23 June could go either way; as a consequence, financial markets are expected to be unsettled over the next few months.

Once the result is known, whether investors' nerves continue to be tested will depend not just on whether the majority of voters want to leave or stay. If the vote is in favour of "Brexit", the issue of whether or not we have an orderly exit from the EU will have a huge influence on market stability.

But, given that the government is officially backing maintaining the status quo, and has therefore been unwilling to divulge what plans are in place if voters opt to leave, that impact is very hard to predict. Given the difficulty of forecasting what lies in store in the months ahead, how should investors navigate the markets?

Keep a close eye on the currency

The pound has already been one of the biggest casualties of uncertainty surrounding the EU vote. International investors have started to fret about the future strength of the UK economy if Britain's relations with its largest trading partner sour.

If polls swerve toward 'leave', much of the market reaction could happen before, not after, the voteThe pound has fallen by over 6% against the euro and 6% against the dollar since the start of 2016.

If the UK votes to stay in the EU, the pound is likely to rally as we return to "business as usual". The consequences of the UK leaving the EU are more uncertain. Capital Economics thinks that sterling could weaken even further against the dollar, to $1.20, in the event of a Brexit.

However, much could depend on the degree to which an exit has been anticipated. If the opinions polls move sharply in favour of leaving the EU then much of the market reaction could happen before, not after, the vote.

Buy beneficiaries of weak sterling

Given their global focus, a weaker pound could also be a blessing for many UK companies.

Leigh Harrison, head of European equities at Columbia Threadneedle Investments, says: "A vote for Brexit would be negative for the equity market as weak sterling and lower growth expectations would reduce earnings forecasts for the market as a whole.

"However, given that 75% of the UK market's earnings base is outside the UK, a weak currency may substantially offset the impact on investment and business confidence."

The impact would not be uniform and Harrison believes this could lead to a switch in market leadership.

He continues: "Companies with overseas earnings may well benefit in reported earnings terms from a weaker pound and certainly investors would be likely to reduce their focus on the domestic earnings-oriented, mid-cap companies, which have led the market for the last 18 months."

Be wary of the banks...

An area to avoid if the UK leaves the EU could be the banking sector - and trouble for the banks could have a negative impact on other parts of the economy.

Any reduction in banking activity would have severe knock-on effects for LondonJohn Wyn-Evans, head of investment strategy at Investec Wealth & Investment, says: "A major concern is the threat of loss of access to European markets, something which is currently permitted via passporting rights.

"It is probable that banks would have to apply for new licences to operate on the Continent, which would reduce the attraction for international banks to base their European operations in London.

"Any reduction in banking activity would have severe knock-on effects for London - both the economy and the real estate market."

...and bonds

A 'stay' vote is likely to push up the price of gilts and sterling-priced corporate bonds, as overseas holders would become more relaxed about holding UK bonds. A rally in the pound would help keep a lid on inflation, which should also be beneficial for bond prices while pushing yields lower.

And if we quit? "The UK is a very open economy and prone to bouts of inflation, especially in response to a weak pound," says Wyn Evans.

"Yields could rise in the face of higher inflation [and bond prices drop], exposing investors to capital losses with limited income to make up that loss.

There will probably be few places to hide in UK assets, and gilts may offer a safe haven"On the other hand, if the economy was undermined, would the Bank of England be forced to stay its hand on raising interest rates to boost growth?"

If that happens, and interest rates are expected to remain lower for longer, bond prices should be supported.

Michael Stanes, investment director at Heartwood Investment Management, adds: "In theory, an 'out' result would be negative for the UK gilt market since there would be questions around the UK's ability to maintain its AAA sovereign credit rating and the threat of capital flight, given the UK's rather sizeable current account deficit which needs to attract foreign buyers.

"However, in reality, there will probably be few places to hide among UK assets, and gilts may offer the safe-haven, risk-off trade, particularly if Bank of England interest rate hike expectations are pushed back as a result."

Don't be paralysed by fear

It is important to put the vote in perspective. Other global factors, such as the Chinese economy, the direction of US interest rates and commodity prices, are expected to remain more significant drivers of financial markets.

Given the many unknowns, it is difficult to come to a firm investment view, as there is a 50% chance you will be wrong.

If the majority of voters opt to stay, or Britain exits the EU smoothly, volatility caused by the referendum could be shortlived.

Conversely, a Brexit could lead to a long period of difficult trade negotiations, spark demands for a second Scottish independence vote, and destabilise the EU as voters in other countries demand a similar referendum. Any of those outcomes could lead to prolonged market jitters.

Against this backdrop, many experts recommend following the time-tested strategy of holding a globally diversified portfolio of high-quality assets.

What to buy to benefit from Brexit

Funds to watch if a Brexit happens could include Jupiter Strategic Bond, according to Whitechurch's Gavin Haynes, who calls it "a well-managed, defensively positioned, 'go anywhere' fixed interest fund".

He also recommends global equity funds focused on high-quality companies, such as Fundsmith Equity and Newton Global Income.

What to buy to benefit from 'Bremain'

If a 'remain' vote sparks a sterling rally, domestically focused stocks could be beneficiaries.

For fund investors, Haynes selects UK equity portfolios focused on the domestic economy. "This leads me towards funds focused on medium and smaller UK companies," he says.

"In this space I like Aberforth UK Smaller Companies, Miton UK Value Opportunities and PFS Downing UK Micro-Cap Growth."

This article is for information and discussion purposes only and does not form a recommendation to invest or otherwise. The value of an investment may fall. The investments referred to in this article may not be suitable for all investors, and if in doubt, an investor should seek advice from a qualified investment adviser.