Reports of a possible agreement on the size of the Brexit divorce bill that could pave the way for a trade agreement once the UK leaves the EU have prompted a surge in the value of Sterling, but the longer term picture is a lot more disturbing.
The Labour party has recently admitted that it has carried out “war-game-type scenario-planning” for events such as “a run on the pound” so that it is ready if it is asked to form the next government. The divisions in the Conservative party make a Corbyn victory a distinct possibility and the collapse of the exchange rate could even happen before that if the Brexit talks break down during the final stages of the negotiations.
In their last election manifesto Labour promised to nationalise the rail and water companies and to bring the Royal Mail back into public ownership. They also announced other large spending commitments that would largely be funded by borrowing. If the plans are not believed to be viable there could be a sharp fall in business and investor confidence and a crash in the value of the pound.
The easiest way for investors to profit from this type of extreme scenario is to increase their exposure to safe haven currencies with the most obvious example being the US dollar. If there was a run on the pound the USD would probably be the main beneficiary.
A currency ETF linked to the USDGBP exchange rate would be the natural way to take advantage. ETFS Long USD Short GBP (LON:GBUS) aims to reflect the performance of a position in forward contracts that are rolled on a daily basis. This is achieved via a derivative known as a swap that is provided by Morgan Stanley & Co and that is backed by collateral to protect against the counterparty risk.
GBUS has assets under management of £1.268 million and an annual management fee of 0.39%. It generates a return that reflects the spot return from the currency pair, the interest rate differential between the two currencies, the collateral yield and the management fee and costs of the swap.
If you like the idea of a US dollar denominated safe haven, but are not comfortable investing in a currency ETF, the two most natural alternatives would be a physical gold ETF such as ETFS Physical Gold (LON:PHAU), or a short duration US Treasuries ETF like the iShares $ Treasury Bond 1-3yr UCITS ETF USD (Acc) (LON:IBTA).
Another traditional safe haven that would be expected to benefit from a run on the pound would be the Japanese Yen. The most likely explanation for its strength during periods of market stress is that during a crisis investors tend to move their money back home and as the largest creditor nation Japan has the most to gain. The most direct way to benefit would be to buy ETFS Long JPY Short GBP (LON: GBJP), which operates in the same way as GBUS.
The other likely beneficiary is the Swiss Franc. This is because Switzerland enjoys large current account surpluses, like Japan, has a stable political system and there is plenty of liquidity in its currency on the foreign exchange market. ETFS Long CHF Short GBP (LON:GBCH) would be the natural way to benefit.
Before you can trade any of these currency ETFs you would need to fill in a complex instruments application form from your broker.