Investors have so far taken a positive, albeit wait-and-see, approach to Brexit negotiations but as deadlines for talks approach, and with no deal yet agreed, investors and financial markets will need to adjust. These are the main findings of State Street's Brexometer Index for Q3 2018, which reflects institutional investor sentiment on the economic impact of Brexit.

The key findings of the quarterly pulse survey show that investor sentiment towards UK assets remains positive on the whole, although Bank of England data released at the end of August showed the largest drop in foreign holdings of Gilts since records began in 1982. Overall, the number of institutional investors looking to increase their holdings of UK assets rose to a record high of 21 per cent, up from 13 per cent in Q2 2018.

The survey also suggests that 43 per cent of investors in Q3 say they have a positive sentiment towards the global economy. However, a growing number of investors anticipate that Brexit will have a major impact on their business operating model, with 26 per cent of respondents believing its impact would be 'significant', up from 14 per cent increase from Q2 2018. State Street says this is the highest score since the index began. The overall proportion of investors anticipating any impact was 83 per cent in Q3.

Other key findings of the Q3 2018 index include:

• 40 per cent of institutional investors believe asset owners will not change their levels of investment risk over the next three to five years;
• regulatory reporting issues, such as those required under Solvency II and AIFMD, remain the most in-need service (28 per cent);
• 17 per cent of respondents believe fund restructuring is another area that businesses will need the greatest help with following Brexit, overtaking performance and risk analytics which fell to 8 per cent; and
• 37 per cent of institutional investors believe their company will use more cross-border fund locations, with locations such as Luxembourg (57 per cent) and Ireland (54 per cent) listed as the most attractive for managers.

Michael Metcalfe, of State Street Global Markets, commented: “Investor sentiment toward UK assets is becoming increasing bifurcated as Brexit deadlines loom larger. On balance, the optimists, those planning to increase their holdings, are still winning the day – just. However, the Bank of England data released at the end of August – showing the largest drop in foreign holdings of Gilts since records began in 1982 – shows this may not be the case across all investor types.”

“The story of Brexit so far is that fears of economic disruption and capital flight have been unfounded and investors have been willing to give the UK the benefit the doubt. But the closer we get to the key Brexit deadlines without signs that a deal can be reached, the more likely it is these fears will become a reality that investors will need to adjust too,” continued Metcalfe.

“Sterling has remained under pressure, reflecting currency markets’ low expectations with respect to Brexit negotiations, with only a brief rally as interest rates were raised,” said Bill Street, head of investments for EMEA at State Street Global Advisors. “The extent of negative sentiment, combined with undervaluation, means that the currency tends to rally sharply on more positive news headlines.”