Scottish Independence Client Update

With the Scottish election vote due on Thursday, we thought we’d send a short note to our clients outlining the potential impact on portfolios and how we are positioning them for it. As always, if you’d like to discuss any of this in more detail please pick up the phone (or e-mail) and get in touch.

Before we talk about the implications of a Yes vote, the first thing we’d note is the markets we follow currently suggest around a 75% probability of a No. This is therefore what we are ready for. If, however, the polls start towards the Yes vote and/or a Yes vote comes through then we would expect to see the following:

 

  • Weaker sterling. Fixed income investors in particular would hate the uncertainty a Yes vote would create. We would expect to see selling of UK assets by some of the hotter international investors and a fall in sterling. We saw the first signs of this early last week when the Yes vote started to gather strength and sterling fell 3% vs the US dollar.
  • Underperformance of UK equities vs international equities. Scottish banks would suffer as their underlying government guarantees would be weaker. Increased uncertainty might hit UK consumer focussed business and property for example. That said, the fundamental earning power of the majority of UK businesses would be unaffected by the change of political control of a country of 5 million people which amounts to around 1% of European GDP. Any sizeable sell-off might well be a buying opportunity which we would look to exploit, especially if a weaker pound helped the underlying competitiveness of UK plc.
  • Finally, political risk would rise in the UK. While Scotland would drift left politically on exit, the rest of the UK would lurch to the right. If nothing else, this would raise the possibility of a British exit from Europe via a similar referendum. This would add to further pressure on sterling and it is likely that the UK would have an uncertainty premium on it for a while from foreign investors.

For the reasons stated above, we’d clearly prefer a No vote. However, we think client portfolios should prove resilient to a Yes for a number of reasons. First, our absolute return funds are focussed on exactly the kind of opportunities we discuss above (e.g. falls in sterling). Indeed, in recent weeks they have been profiting as currency markets have become more volatile once again. We think they would be well positioned to profit from some of the opportunities a Yes vote would create.

Secondly, we remain committed to a broad diversification of risk in our client portfolios. The majority of our equity exposure is in fact international (concentrated in the US and Europe). We think a Yes vote would have little impact on these investments and for some the value will rise in sterling terms if sterling weakens. Finally, we have not yet discussed UK government bonds. The outlook here is unclear: we would expect a move to safer assets on a Yes vote which should be good for UK government bonds. That said, UK government debt would ultimately be divided between the two countries so there would be two weaker sovereigns looking to repay them rather than one stronger one. A mini Eurozone if you will. The longer term outlook for this sort of arrangement is not good. We therefore think the longer term risks rise for UK government bonds and so are maintaining our very low exposure to this asset class.