Effects of Brexit difficult to quantify as COVID-19 muddying the waters

Five years on from the U.K.'s referendum vote to leave the European Union, money managers are still searching for data to quantify its hits to the U.K. economy.

That's not because there is no data — markets have continued to operate, trade is still happening and statistics are still published by official entities — but rather because such data has been distorted by a much bigger concern: COVID-19. While the U.K.'s decision to leave the EU was revealed on June 24, 2016, it wasn't until January 31, 2020, that the U.K. officially left the bloc and began a set of negotiations with the EU over future relationships in financial services and other sectors.

And then COVID-19 hit markets in March.

"It's harder to assess the Brexit impact (five years on) because of COVID," John Roe, London-based head of multiasset funds at Legal & General Investment Management, said in emailed comment. "The virus, and associated fiscal stimulus, has caused so much volatility that underlying trends are harder to pick out." LGIM runs £1.3 trillion ($1.8 trillion) in assets under management.

Mr. Roe thinks underlying trends will be difficult to differentiate throughout this year because the U.K.'s COVID-19 vaccination program is several months ahead of other European countries and no fiscal tightening is expected until 2022 at the earliest.

Meanwhile, the U.K. and EU are still thrashing out final details on some areas of financial services, while money managers continue to develop their operations in the U.K. and on the continent as they work around the loss of passporting rights.

Other executives agreed that COVID-19 has muddied the impact of Brexit.

"Brexit is important longer-term in terms of how the U.K. functions, but it's still less important than COVID(-related) reopening," said April LaRusse, London-based head of fixed income at the £707.7 billion Insight Investment. "Fortunately — or not fortunately — we haven't been focused on Brexit more or less since the vote happened, and we (then) calmed down." When the U.K. left in early 2020, it was a bit of a "non-event, mainly because we had something bigger to worry about" that quarter — COVID-19. "I'm sure when we are less focused on COVID there will be more focus on Brexit," Ms. LaRusse said.

Insight executives are looking at data from sources including the U.K.'s Office for National Statistics' report on the effects of the exit and the coronavirus on U.K. trade in goods, published in May. "I was trying to look for some useful data (in the publication) — anything we can see that suggests the U.K. is hurting because of Brexit. The data is going to be messy because of COVID. But you can definitely see in the data … a pretty material decline" in total trade in goods with EU countries, down 23.1% between the first quarter of 2018 and the first quarter of 2021. Stockpiling of inventories in the fourth quarter of 2019 — immediately ahead of the official exit — also would have "muddied the numbers somewhat," Ms. LaRusse said.

The difference in market effects due to COVID-19 and Brexit are stark. At the depths of the COVID-19 crisis for markets — March 23, 2020 — the S&P 500 index dropped almost 35% and the FTSE All-Share index fell 35% through that date.

However, on June 24, 2016, the FTSE All-Share index fell by 3.8% vs. the previous day. The pound sterling bore the brunt of the impact, falling more than 10% against the dollar in early trading on the morning the referendum result was revealed, and continued to be volatile over the coming years, dropping at points to around $1.20. However, year-to-date June 24, 2016, the FTSE All-Share index gained 2.8%.

And during market trading on Feb. 3, 2020 — the first day after the U.K.'s official exit — the FTSE All-Share index fell slightly and the pound dropped to $1.30 from $1.32 on Jan. 31.

Compared with COVID-19, "Brexit is more of a slow burn," Trevor Greetham, head of multiasset at Royal London Asset Management in London, said in an email. The firm has £147 billion in assets under management. However, "a renewed bout of sterling weakness could occur if the government refuses to abide by the Northern Ireland Protocol and we end up, in effect, in a 'no deal' situation," Mr. Greetham warned, referring to part of the Brexit deal that keeps the border between Northern Ireland and the Republic of Ireland open.

LGIM's Mr. Roe added: "The good news is that any cliff-risk from Brexit has been avoided and the issues that now need to be dealt with, like encouraging business investment to stimulate productivity, are slower-moving issues so the risk of a crisis has dwindled dramatically."

That was a large part of the firm's decision to take a long position on the pound sterling in November, "as we could see that funnel of doubt rapidly shrinking, which in turn made (the pound) attractive as it was both unloved and cheap on various valuation metrics," he said.

The reality is that markets have "kind of dismissed it," said Andrew Jackson, head of fixed income at the international business of Federated Hermes Inc. in London, speaking on a virtual panel event on June 17. While Brexit is relevant, it may be "bad, may be good, but only marginally bad or good," he said. Corporations got ahead of the official exit, managed risks and communicated them well, Mr. Jackson added. Federated Hermes has $625 billion in assets under management.

But concerns do remain, including the impact of "rules of origin" — the need to demonstrate that goods originated in the U.K. or EU before they can be distributed — on supply chains and "the uncertainty over the treatment of parts of financial services. The risk is that a combination of the rules, frictions and ongoing uncertainty undermine business investment," Mr. Roe said.

Insight's Ms. LaRusse said there is some evidence of delays in terms of bringing goods into the U.K., which is affecting costs. She also cited the rules of origin protocol as a risk. "There is some evidence to suggest there are frictions in the system, which are leading to less trade, and potentially that hurts the U.K. economy," she said.

And Hermes' Mr. Jackson added that supply chains will continue to be disrupted. "But I think in some ways, the last year has been a good time to have Brexit occur — there's been a global pandemic and some of those supply-chain effects have not been noticed," and markets have gathered "all the bad news together in one big chunk," he added.

And any further bad news that causes another drop in sterling would actually boost domestic stock prices because about 70% of FTSE 100-listed company revenues are earned overseas, RLAM's Mr. Greetham said.

Christian Kopf, Frankfurt-based head of fixed income and FX at Union Investment Institutional GmbH, thinks Brexit "is largely priced into financial markets by now. In fact, we believe that after lagging global equities for many years, U.K. equities now offer good potential, as valuations look attractive."

That is especially true for midcap stocks — those listed on the FTSE 250 index — "which tend to perform well in economic recoveries. But even large caps now look cheap by historical standards," he said in an email. Union has €386 billion ($467.4 billion) in assets under management.