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By Alina Lamy | 06-08-2016 12:00 PM

What Does Brexit Mean for U.S. Investors?

As Britain weighs the immigration, cost-benefit, and trade implications of E.U. membership, U.S. investors should check their risk exposure to Europe.

Alina Lamy: On June 23, the U.K. will hold a referendum to vote on whether it will exit the European Union, an event that has become commonly known as Brexit, or Britain’s exit. The central question (not a simple one) is whether Britain would be better off by itself or as a member of the E.U. Multiple developments have led to this, and the stay-versus-leave argument revolves around a few central issues: Immigration, the cost versus benefit of belonging to the E.U., and the potential implications for Britain's trade operations.

Concerns over increased immigration and its effects (many of them familiar here in the U.S.) have become more pronounced recently, especially as Europe confronted waves of Syrian immigrants and faced the conflicts and tensions this situation inevitably gave rise to. The percentage of immigrants coming into the U.K. from the E.U. increased to 42% in 2015 from 29% in 2010. These numbers, along with the fact that migrants put pressure on a country’s social and economic systems, are mainly an argument used by the "vote leave" proponents, who point out that by leaving the E.U., Britain would be able to set more stringent controls and more effectively manage the flow of immigrants.

Another point of contention is the money that the U.K., as an E.U. member, has to pay into the E.U. budget every year. The figure that the "vote leave" camp is quick to point out is Britain's on-paper contribution in 2014: GBP 19.1 billion. Critics argue this money could have been put to much better use internally. What they fail to point out, however, is that E.U. members contribute to the E.U. budget, but they also receive benefits in return.

The U.K. is the beneficiary of a previously negotiated rebate agreement, which in 2014 amounted to GBP 4.4 billion. And the U.K. also received public-sector payments from the E.U. through the European Regional Development Fund and the European Agricultural Guarantee Fund, payments totaling 4.8 billion. Given these figures, the U.K. Office of National Statistics reports that the U.K. government's net contribution to the E.U.--that is, the difference between the money it paid to the E.U. and the money it received--was GBP 9.9 billion in 2014. Quite a difference from the much-mediatized 19.1 billion.

And, finally, there is trade. A sizable 57% of Britain’s exports go to E.U. countries, notably Germany and France. Right now, these markets are easy to access because the trading practices, regulations, and standards are uniform throughout the E.U. If Britain leaves the E.U., things might become considerably more difficult. The E.U. might decide to impose tariffs or trade restrictions that would hurt Britain's exports, or even sanctions to discourage other countries from leaving the union.

So overall, would Britain be better off alone or as an E.U. member? By leaving the union, Britain wouldn't have to conform to the union's regulations and would enjoy more political and economic independence. On the other hand, Britain would also lose some of its international political clout as a stand-alone entity, compared with the power it enjoyed as a major player in an international regulatory body whose decisions it could influence better from within than from without.

A "Brexit" could result in a weaker Britain and a weaker E.U., at least in the short term, and could cause instability and volatility that would take a while to resolve. As far as implications for U.S. investors, weaker or unstable European economies could mean stock-market declines that would hurt returns, and asset flows trends showed us that U.S. investors increased allocations to European stocks last year. Potential damage could be exacerbated if the pound and the euro depreciate, diminishing the returns of overseas investments even further. This doesn’t mean that investors should drop their European holdings altogether, but rather that a portfolio allocation checkup is in order to make sure international holdings are well-adapted to each investor's risk tolerance and time horizon.

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