Steering clients through Brexit volatility

Drawdown clients may have to revisit the basics as Brexit looms

Unless your clients have been living under a rather large rock for the past few years, they will be aware that the UK, as it stands, will be leaving the EU on March 29.

Under what terms the UK ends up departing, or whether there is a deal in place at all on this date or, indeed, whether the exit date is delayed, all remains to be seen.

It is precisely this lack of clarity that may be causing some clients to feel concerned about what impact this might have on stock markets and therefore on their short-term pension saving and investment needs.

Anyone planning to retire in the next few months and go into drawdown may be wondering how they can prepare for what might be a volatile few months in the stock market.

What impact could a sudden fall in the FTSE 100 have on their pension pot, just as they plan to draw an income from it?

But then, advisers are used to telling clients to maintain their focus on the long term and not get distracted by political or macro noise.

So is Brexit any different?

Scope for volatility

Rebecca O’Keeffe, head of investments at interactive investor, explains: “Volatility – a measure of the ups and downs in the stock market – is a double-edged sword.

“With Brexit now so close, markets have tried to price it in already, but risks remain on both the upside and downside.”

She notes: “Bank of England governor Mark Carney [pictured] observed [recently] that the range of possible outcomes remains as wide now as it was the day after the referendum. So, diametrically opposed outcomes are still very possible, meaning there’s scope for substantial volatility.”

As Adrian Lowcock, head of personal investing at Willis Owen, points out, a no-deal Brexit is supposed to be priced into markets, but he cautions this does not mean there will not be volatility.

“Expect the pound to fall, at least for a while, and the Bank of England may well respond with a cut in interest rates,” he says.

“Savings rates are more likely to fall than rise in the short term. Typically, the FTSE 100 has risen when the pound falls, but Brexit day might be slightly different.

“Initially, this reaction could be short-lived – [it] just depends what happens on day one, two or three. If things don’t seem notably different then markets may just adopt a ‘wait and see’ approach, as they have pre-Brexit.”

Currency markets have also proven to be at the whim of Brexit-related developments, so understanding the impact currency exposure could have on client portfolios is important.

Brexit news typically impacts sterling more than equity markets, according to James Beaumont, international head of portfolio research and consulting group at Natixis Investment Managers.

He suggests it would be timely for advisers to review currency exposure within client portfolios.

“Most advisers that have unhedged non-UK equity exposure are de facto short sterling through their US, European and emerging market equity exposure and, therefore, benefit from negative Brexit news on that part of their portfolio,” he explains.

“In terms of advisers’ domestic equity exposure, those invested in the FTSE 100 are typically less impacted by negative Brexit news, because the majority of its constituents have earnings outside of the UK – but this is less the case for UK small-caps.”

Ms O’Keeffe agrees: “The main impact to investors over the coming weeks is likely to come from a move in sterling and the knock-on effect on the UK and international equity markets.

“A soft Brexit would result in a significant rally in sterling, which could mean that the sterling price of the bigger global international companies listed on the FTSE 100 might fall. However, a soft Brexit would result in potentially substantial upside for UK-focused equities.”

She continues: “A hard Brexit would see sterling fall sharply as dislocation to trade, supply chains and access to markets throws many economic certainties into total disarray.

“UK-focused equities, and those most directly affected by UK-EU trade could get hit hard, whereas international companies listed in the UK might offer a relative safe-haven.”

More engagement

Are advisers seeing more queries from clients about the potential impact of Brexit on their portfolios?

Chris Justham, head of discretionary, London and southeast, at Seven Investment Management, says when he joins advisers in meetings it is the “hot topic”.

But he suggests one of the positives to come out of it is that people “seem more engaged with the investment of their money than ever”.

He also believes this is where the adviser can play a part in offering reassurance to clients and managing expectations.

“I think you can take steps to mitigate the impact of that short-term volatility. You can do that in a number of different ways,” he suggests.

“I think a relatively straightforward way is segmenting a portfolio into pots based on short, medium and long-term needs. That can be across multiple different tax wrappers but it’s going back to the basics of, what is it the money is needed for?

“Because if it’s over the long term, you have to rely on your investment manager, for example if you’ve outsourced it, to do their job and take actions within the portfolio to mitigate those fluctuations accordingly.”

Mr Justham says: “Generally speaking, if you have a client, and we’re talking specifically about drawdown here, where they’re either taking income or they’re imminently expecting to take income – these are people who are going to have to draw down from their pot.

“Ultimately, they need to make sure they don’t run out of money. A big goal risk there is their portfolio falling significantly in value and therefore the vagaries of pound cost ravaging, where they’re having to take money from their portfolio when it’s already fallen.”

Pound cost ravaging is a phrase that will be familiar to advisers and is certainly something their clients with impending retirement income needs may well be concerned about.

Cash is king

Ms O’Keeffe warns when markets are more volatile it does matter whether clients are building up their portfolio or drawing it down.

“Volatility potentially benefits investors who are regularly investing; the concept of pound cost averaging means you will be able to buy in at lower levels if markets take a tumble,” she explains.

“However, if you are withdrawing money on a regular basis then falling markets are bad news, known as pound cost ravaging. Regular amounts of money that are being taken out to fund a pension mean that you potentially have to sell more units, so you don’t have as much invested and can’t benefit if markets subsequently recover.

“Investors who are drawing down their pension might want to consider if they can reduce the amount of income they take should markets experience erratic falls.”

One way to do this is to set aside more held in cash at this point.

Mr Justham suggests advisers ask clients to think about how much they might need to hold in cash to be able to meet any short-term obligations and be less affected by the ups and downs of the stock market.

In other words, as he puts it, this is a good time to “revisit the basics” with clients.

Joe Roxborough, a chartered financial planner at Ascot Lloyd, says: “Many investors read uncertainty as something to be feared, and others view it as an opportunity to strike while markets are, by many metrics, underpriced.

“In these situations, ensuring a pragmatic approach to your investments is crucial, and most investors would rather avoid a loss than make a gain. However, a too cautious approach over a longer period of time can hugely impinge on growth.”

He suggests covering off the following three areas in conversations about Brexit:

1. Are you expecting to drawdown any large amounts in the near future? Investors should aim to have six months to a year’s worth of expenditure in cash. If clients do not have this to hand, the recent rally in prices could be an opportunity to take some profits and rebalance to create this cash.
2. Be careful of internet opinions. No-one knows what Brexit will look like, nor the effect it will have on investment markets. Not only was voting to leave the EU in 2016 the less expected result of the referendum, but the impact on markets was not what most pundits expected either. In short, be careful of making dramatic moves in your portfolio based on compelling writing.
3. Diversify and rebalance – asset allocation is crucial, and not all of your investment returns will hinge on the outcome of Brexit. Over-investing outside of your comfort zone purely on expectations for the impact Brexit will have is gambling and should be treated as such.

For those clients specifically with retirement planning needs, Mr Lowcock explains: “The best idea is to have a plan to transition from your accumulation phase to the decumulation phase and look to move your investments to be positioned for retirement over a three to five-year period.”

As well as having cash to hand to meet immediate income needs, he explains clients should be well diversified.

“Global equities have been a good place to be post-referendum and still offer some attractive opportunities,” he observes. “For most of the rest of the world, Brexit is of little or no significance.

“Thirdly, don’t panic – the next six months are likely to be challenging and the uncertainty is likely to weigh on the minds of investors for some time.”

Income needs

But clients reaching retirement might also need to think about the prospect of rising living costs, Mr Lowcock points out, adding, “so clients might find their income needs actually change”.

“This is largely unknown but should be planned for, so having the extra cash cushion will do wonders to protect clients’ standards of living in the short term,” he notes.

“Longer term they may need to re-plan their retirement if costs go significantly higher for a sustained period.”

It might be easy for advisers and their clients to be thrown off course by Brexit and any subsequent volatility.

Mr Beaumont points out: “There are so many possible outcomes, with so many ramifications we would be very wary of trying to ‘trade Brexit’, and also wary of focusing so much on Brexit headlines that you take your eye off other risks and threats that may actually have far greater consequences for a client’s portfolio.”

eleanor.duncan@ft.com