Hard Brexit could impact more than markets for fund investors

Danielle Levy considers what UK investors need to think about ahead of the March exit day.

With just a few months left to go before the UK leaves the European Union (EU), investors are likely to be feeling nervous. At the time of writing, the UK had a potential deal on the table with the EU. However, with several challenging hurdles still to clear, it’s difficult to rule out a ‘no deal’ or ‘hard Brexit’ scenario, which would see the UK give up full access to the single market.

So, ahead of the Brexit deadline on 29 March 2019, what should investors think about?

For those who invest via funds, no-deal or hard Brexit could have implications beyond the impact on markets. This is because many UK savers invest in funds based in the EU and typically domiciled in Dublin and Luxembourg. These ‘Ucits’ funds include ETFs, index-trackers and active funds. The Investment Association estimates that UK investors currently hold £375 billion in Ucits funds domiciled in the EU.

After Brexit, the UK will become a ‘third party’, a country with an economic relationship with the EU but not a member. This is significant for Ucits investors because there is no ‘third-country regime’ in place for Ucits funds, which means it could become difficult for UK investors to buy these funds after Brexit.

In a briefing paper published in September, the Investment Association urged the UK government to remain open to non-UK Ucits funds post-Brexit, irrespective of the wider negotiations regarding financial services. “We need a clear commitment that this will be allowed post-Brexit, both for the existing stock and new funds,” the trade body said.

On a positive note, the Financial Conduct Authority, UK financial watchdog, and the Treasury have committed to a “temporary permissions regime”. This guarantees the inward sale of EU Ucits funds registered on or before 29 March 2019, for at least two years in the event of a hard Brexit.I do not therefore expect any issues in holding Irish or Luxembourg domiciled funds,” says Peter Sleep, a senior investment manager at Seven Investment Management.

Nick Marshall, head of fund solutions at Peregrine & Black Investment Management, echoes his sentiments. “The FCA is doing everything it can to ensure that UK investors can continue to buy Dublin or Luxembourg funds, so there should be limited impact, if any,” he adds.

Nevertheless, as a deal is yet to be done, it could be worth monitoring this situation to see what the lie of the land is once the two-year transition period comes to an end. A worst-case scenario would be that UK investors face less choice when it comes to selecting funds.

Beware open-ended property funds

The events that followed the EU referendum in June 2016 may prove to be relevant to the way investors respond to a deal or no-deal scenario in March.

In the UK property market, the vote sparked a wave of selling, which put pressure on fund managers unable to sell properties quickly enough to generate the cash that they needed to return to investors. This resulted in six open-ended property funds suspending trading, while others imposed penalties of 10% to 15% to discourage investors from withdrawing their money. 

Daniel Lockyer, manager of the MI Hawksmoor Distribution fund, suggests that investors could benefit by avoiding or minimising their UK open-ended property fund exposure as we approach the Brexit deadline. This could help to minimise any fallout if the UK property market comes under further pressure.

I wouldn’t own UK open-ended property funds. You want to make sure you are in something that is liquid, so that if something really bad happens you want to be able to trade,” he explains.

The Brexit vote also impacted investment trust investors, causing UK small cap and commercial property sectors to swing out to large discounts. While UK-focused real estate investment trusts (Reits) later recovered in 2016, it hasn’t been as straightforward for listed funds invested in small and mid-caps. They have continued to trade at high discounts; today the AIC UK smaller companies sector trades at a discount of 8.4%.

Mick Gilligan, Killik & Co’s head of fund research, points out that a lot of bad news is already priced in, so he would be surprised to see discounts widen much further. “It would have to be a very hard Brexit to spark a meaningful shift out in discounts,” he argues.

Lockyer agrees. “I don’t think there will be that much volatility in discounts if we receive more negative news. Most likely, if we hear positive news discounts should narrow.” Nevertheless, he notes that it could take some time before this happens.

Perhaps the biggest headwind facing fund investors right now is uncertainty, so once the market gains clarity either way things may well start to improve.

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