How to invest with a hung parliament

16 February 2010

With the general election just a few months away, some commentators fear the result could be a hung parliament.

If this were to happen, it would potentially spell bad news for the economy's recovery and for private investors' portfolios.

Mark Bolsom, head of the UK trading desk at Travelex, says: "The UK is experiencing real economic uncertainty at the moment - a ballooning budget deficit, promises of higher taxes and swingeing spending cuts, as well as creeping inflation. Political indecision is exacerbating this as the markets get anxious about the possibility of a hung parliament."

However, the former Conservative chancellor Kenneth Clarke has reportedly said he'd prefer to see a Labour win than a hung parliament, because the latter could severely derail our ability to climb out of recession.

What does it mean?

A hung parliament occurs when no political party manages to gain an overall majority. This means no party has more than half of MPs in the House of Commons.

If this happens, then the party with the largest number of seats will be able to form a government, perhaps by creating a coalition with another party. 

Alternatively, the 'winning' party would have to rule as a minority government - meaning it would be unable to pass laws without the support of other parties.

The third option is for parliament to be dissolved and another election held.

What will happen?

"Recent opinion polls in the UK have shown an increasing chance that the next general election could lead to a hung parliament," says Nicola Marinelli, fund manager at Glendevon King Asset Management.

"This could be a problematic scenario for sterling-denominated investors, as political uncertainty over the making of tough economic decisions will not be taken well by financial markets."

The probable impact could be a slide in the value of the pound, a volatile stockmarket, a credit rating downgrade for UK gilts and a fall in the value of gilts and of bonds issued by UK companies, he warns.

Stuart Thomson, economist at Ignis Asset Management, recently warned there was a 50% chance of a hung parliament. If it does occur, he says the rating agencies are likely to give any new coalition at least a month to agree upon sufficient fiscal measures to retain the country's triple AAA rating. 

"However, there is about 20% probability that this coalition leans to the left and decides that ratings are for bankers and refuses substantial cuts in fiscal expenditure thereby precipitating a sterling crisis," Thomson adds.

What can investors do?

Marinelli gives three tips to bond investors in case this year's election does lead to a hung parliament:

1. Buy short-term gilts

If gilt prices are pounded by the markets, especially after a rating downgrade for UK, investors should position themselves at the short end of the yield curve, as these gilts' prices usually move the least.

2. Buy short-term UK government guaranteed bonds

If the recent experience in Greece, Spain and Portugal is any indicator, UK corporate bonds could be hit in the event of a downgrade or the possibility of a downgrade. Once again, our view is that safety lies at the short end of the yield curve and with corporate debt that benefits from a UK government guarantee; of these, we favour the building societies.

3. Buy foreign currency bonds

In the event of a hung parliament, the pound is likely to fall in value against the US dollar and the euro. Owning bonds denominated in the euro or the US dollar will increase in value for a sterling-based investor if the pound falls against these currencies.


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