Brexit — when the United Kingdom officially exits the European Union, an event scheduled to take place officially at 11 p.m. on March 29, 2019 — will likely not unfold as abruptly as initially anticipated.
The prospect of a softer Brexit became apparent this March, when the U.K. government and E.U. leaders said that they had reached an agreement that would allow for a 21-month additional period post-Brexit to smooth the way for relations between the British and other Europeans.
For many veteran U.S. advisors, Brexit never meant immediately pulling out of the U.K. bond market even before the two sides announced the transition deal and that was definitely more the case afterward
“We have no current anticipation of extricating from U.K. fixed income,” says Bradford Long, the research director of global public markets for DiMeo Schneider & Associates of Chicago.
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J. Brent Everett, founder, chief investment officer and partner at Talis Advisors in Plano, Texas, agrees.
“The U.S. only represents about 30% of the global bond market. This makes non-U.S. bonds the world’s largest asset class,” Everett says.
“International bonds expose investors to different economic cycles, inflation and interest rates. We believe that broad exposure to international bond markets provides a clear diversification benefit,” Everett says.
“The U.K. represents about 7% of the global bond market,” he says.
Although volatility may rise in the British pound “due to the uncertainties surrounding Brexit,” Everett says, “it’s not likely to be significant in a broadly diversified global portfolio.”
But precisely because of currency volatility, he recommends taking steps to counter those events.
“An important point to note on international bonds is the need for currency hedging. Otherwise, currency exposure can create volatility that is significantly above the level of the underlying investment,” Everett says.
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More currency volatility is also what Long identifies as the most identifiable risk as a result of Brexit.
As a rule, fixed-income risks fall into two categories, he says, “the known unknowns and the unknown unknowns.”
With Brexit, there are new known risks rising on the horizon.
For instance, Northern Ireland would vote overwhelmingly in favor of remaining in the E.U. if a second referendum were held, according to recent surveys.
Meanwhile, the British government is attempting to map out border systems between Ireland and Northern Ireland in the post-Brexit era, and some predict that during that period the historic violent disputes between the two could resume.
But for Long, so far none of the developments have kept him away from British bonds.
“There are material decisions that could have an influence on the fixed-income market,” he says.
For now, Long is holding tight.
“We are not going to make a policy that we have no clear insight into at the moment,” he says.
This story is part of a 30-30 series on evaluating fixed-income opportunities when rates are rising.
