Brexit creates opportunity but uncertainty remains, experts warn

The referendum result has created roiling change across the UK economy and political landscape over the past week. The shock result led to drops in the pound and UK equity markets in the days following. Gilt yields also fell, prompting a sharp rise in scheme deficits.

During the referendum campaign, many experts warned of negative economic consequences should the UK vote to leave the EU. Simon Hill, chief investment officer at consultancy Xerox HR Services, said clients had been warned to prepare for uncertainty.

It’s important schemes are communicating with their members. The worst outcome would be if people were to withdraw

Simon Hill, Xerox HR Services

“One of the things we said was there would be a sharp reaction whatever the result. [We were] telling schemes to look at their cashflow needs and make sure they had raised sufficient cash to take them through to the end of the year so they didn’t have to sell assets at an inopportune time.”

While the result of the referendum is now known, whether the UK will leave the EU is not. Neither is the relationship it will have with the EU henceforth. Hill said schemes should “minimise transaction volume” until there is more clarity on what comes next.

This also applies to individual members of defined contribution schemes, he said, as they may be concerned about the risks the market turmoil poses to their pension pots.

“It’s important [schemes] are communicating with their members. The worst outcome would be if people were to withdraw.”

Global diversification protects schemes

The uncertainty on the way forward is compounded by uncertainty on the timescale for negotiations to begin, said Hani Redha, global multi-asset portfolio manager at PineBridge Investments. Article 50 – the provision in the Lisbon treaty that begins the process of negotiations by which a nation leaves the EU – has not been triggered, and some doubt it will be.

“How short is the short term we’re talking about?” said Redha. “The outcome is not clear; until that happens it’s not wise to take any drastic action.”

He added that leaving the single market would likely be “very damaging” to the UK.

Redha said UK schemes' home bias in their investments was exacerbating the effect of the markets on their portfolios.

Rupert Brindley, managing director of pension solutions and advisory at JPMorgan Asset Management, said schemes with global diversification had been able to weather the vote far better.

"Global diversification has been very useful. This is a significant incident, but from a US perspective it’s not earth-shattering. The protection you get by global diversification has been very helpful," he said.

Brindley noted that the sharp fall in sterling has created an opportunity for pension schemes.

“It’s likely that sterling will fall further, and there will be further gains to be made by pension schemes," he said. "It’s an opportunity to reap rewards on foreign investments.”

The fall in gilt yields had also brought down swap rates, he added.

Covenant risk might increase

Given the effect of the Brexit-induced market volatility on British businesses, Brindley said trustees should look to carry out covenant reviews to assess the risk to their sponsoring employer.

“It’s important to make sure your strategy doesn’t double up sponsor risk,” he said.

“You have to think about the affordability of running the pension scheme. Where you might have been tempted to pay out for expensive LDI, that might be putting strain on the company and creating undue risk.”

Hill echoed this: “Do not take it that the covenant is unchanged,” he said. “Keep cashflow needs under review.”