In our previous article we examined how likely it is that the U.K. will vote to leave the European Union (EU) and how a Brexit could affect its economy. In short a Brexit would likely involve a large drop in the value of the British pound and a slowing of the British economy.
How can investors protect themselves in the event of a Brexit? Well the easy answer is simply sell short the British pound and be done with it. But what if your brokerage doesn’t support currency trading? What other options do you have?
Go long the Swiss franc
The most popular alternative hedge for a Brexit is going long the Swiss franc. Numerous financial media outlets have written it up as an idea, and it has been frequently mentioned by currency strategists at the major investment banks.
The idea is that, because the Swiss franc is viewed as a safe haven currency, in the event of a Brexit it will rise. In the event that "Remain" wins the day, the thought is the franc won’t fall very much since investors will be unwinding their sterling hedges. I’m not sure if I completely agree with that line of thinking. After all if every currency strategist is out there recommending the trade then how crowded is it becoming? Is it really going to be the situation that the Swiss franc won’t be down that much if everyone is piling into it in an attempt to hedge a Brexit?
Furthermore, the Swiss National Bank has explicitly stated it will intervene to prevent the franc from rising “too high.” Given that the Swiss National Bank can print Swiss francs until he cows come home (subject only to political risks), it will be interesting to see how high the Swissie is allowed to appreciate. It’s likely the Swiss franc trade will be a good hedge but perhaps not the great trade “no lose” trade it’s being made out to be.
The Guggenheim CurrencyShares Swiss Franc Trust (FXF, Financial) seems to be the best vehicle to implement the long Swiss franc strategy.
Go long the yen
The Japanese yen is another safe haven currency. I haven’t seen the idea of using the yen as a hedge written up as widely as I’ve seen the Swiss franc hedge written up. It’s possible that going long the yen might be just as good as a hedge as going long the Swiss franc. Additionally, the Bank of Japan hasn’t been as active as the Swiss National Bank in attempting to devalue its currency. Indeed the Swiss franc is up only about 4% versus the dollar this year compared to 13.5% for the yen. It’s possible that the yen could appreciate more than the franc; as one of the least popular hedges it might have less downside risk should Britain vote to remain.
The Guggenheim CurrencyShares Japanese Yen Trust (FXY, Financial) seems to be the best ETF to implement the long Japanese yen hedge.
Go short the euro
The thinking is, and I agree, that in the event of a Brexit the euro will fall along with the pound. If Britain votes to leave the EU, it’s likely to put even more strain on the multination currency bloc that still hasn’t solved its current economic crisis. In fact, I’d argue that Britain leaving the EU would be worse for the EU over the long run than for Britain itself. Britain has its own currency, and all David Cameron and George Osborne have to do is stop their austerity push and simply increase fiscal spending and the economic damage of leaving the EU will be reversed. Should Britain vote to remain, the euro is likely to rally so going short the euro has a similar risk/reward profile to going short the pound itself.
The ProShares Ultra Short Euro (EUO, Financial) is one way to implement this strategy. It’s a levered fund designed to provide twice the returns of the daily change in dollar:euro exchange rate. Be cautious with this fund. It is much more thinly traded than the other ETFs mentioned in this article. It is also a leveraged ETF so it is not designed to be held for long periods of time.
Do nothing
For long-term investors who don’t care about short-term fluctuations the best option is probably doing nothing. After all, a Brexit doesn’t actually change much at all in the near term. It will take years for Britain to extricate itself from the EU and renegotiate trade treaties. Heck, there is even a chance that another referendum on the EU is held before Britain actually completes its exit and everyone votes to stay. This wouldn’t be the first time another referendum has been held when the EU technocrats don’t get the answer they wanted from the first one.
The most important economic issue in the event of a Brexit in my opinion will be large multinational corporations shifting hiring to continental Europe because of the uncertainty surrounding a vote to Leave. Couple this with David Cameron’s renewed austerity push and you have a recipe for stagnant economic growth in Britain. I’d seriously consider reducing exposure to stocks that derive a large portion of their revenues from the domestic U.K. market. In fact, this is the option we’ve chosen. Large multinationals that happen to be headquartered in Britain but derive a significant portion of their revenue from outside the U.K. and the EU should be minimally affected economically but could see significant fluctuations in share price due to changes in the value of the pound.
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