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Testing the Brexit downside: MSCI's best and worst-case scenarios

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Institutional portfolios could lose nearly 8% of their value under a ‘hard’ Brexit scenario, according to analysis carried out by MSCI.

On the flip side, a positive outcome in the UK’s favour would add 3.5%, the data firm’s risk tools indicated.

MSCI examined three scenarios that it described as “rough Brexit”, “smooth Brexit”, and a Brexit that benefits the UK.

Thomas Verbraken, vice president of risk and regulation research at MSCI, said that each scenario imagined a series of shocks, which MSCI applied to a globally diversified portfolio (60% equity, 40% fixed income).

“Markets would price in new perceptions in a short period of time,” he added.

The “rough” Brexit scenario imagines the UK failing to conclude new agreements and custom rules with its major trading partners before the end of the two-year period for exiting the EU once Article 50 is triggered. Scotland voting to leave the UK also “fits into this scenario”, said MSCI.

Other assumptions include the pound weakening 16% against the dollar and the euro, and sharp falls in equity markets in the UK and the EU.

If such a scenario were to materialise, a globally diversified multi-asset class portfolio could lose as much as 7.8%, according to MSCI. A risk-parity portfolio with enhanced exposure to global bonds might mitigate the impact, losing 5.8%. Global equity portfolios were expected to lose as much as 11% on average.

If the UK were to successfully conclude trade deals with the EU, but with fewer benefits than before, portfolio losses would be lower, MSCI said.

In such a “smooth” Brexit scenario, the data provider said a globally diversified multi-asset class portfolio would lose “as much as 1.6% of its value”, while a risk-parity portfolio would lose 1.1%.

The third scenario envisaged the UK being perceived as “an island of safety” due in part to bilateral trade relations with the US and China, while anti-EU parties were propelled to power across Europe. Assumptions include sterling gaining 16% against the dollar, UK equities gaining while European stocks fall, and investors pricing in a higher risk of defaults in Europe.

If this were to occur, the same portfolio as tested for the other scenarios could gain as much as 3.5%, while a risk-parity portfolio could lose 3%, according to MSCI.

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