U.S. Markets closed

The world's largest hedge fund identified the 'huge problems' the Brexit poses

Revellers wrapped in European Union flags walk at Worthy Farm in Somerset during the Glastonbury Festival, Britain, June 22, 2016. REUTERS/Stoyan Nenov

In a closely-watched referendum, British citizens decided on Thursday to exit the European Union, with 52% voting “Leave” versus 48% for “Remain.”

The shocking outcome resulted in a global market sell off and caused gold to rally. British Prime Minister David Cameron also resigned.

The concern is that the Brexit decision could signal other member countries to hold referendums to leave the EU, according a client note sent this morning by Bridgewater Associates, the world’s largest hedge fund with $170 billion under management.

“The UK voting to leave the EU is a clear warning signal that the rise in populist/separatist positions has reached levels that they can change the status quo significantly,” Bridgewater's co-CIO Greg Jensen wrote in the note seen by Yahoo Finance.

The EU is made up of 28 (now 27) member countries, and it allows for the free movement of goods, services, workers and capital. Basically, if you’re a citizen of an EU member country, you can freely live and work in another member country and use its health-care system and other services.

According to Bridgewater, other European countries holding referendums could pose "huge problems."

"Given how easy it is to move capital within the Eurozone, any rise in risk of a country leaving could easily cause a pickup in capital outflows that could threaten the country’s banking system (as we saw during the sovereign debt crisis). And this could extend to other countries perceived as potentially vulnerable to leaving as well," the note said.

It continued: "The ECB would then be faced with the choice of whether to step in (increasing its exposure to a country that might walk away from the liabilities) or institute capital controls like in Greece last year. The prospect of such pain and disruption lowers the probability of such an event occurring. But even given the low probability, it looks to us like markets are under-discounting the risk."

In all, Bridgewater noted that on a global scale, the Brexit is a "rather modest political outcome." But that said, it resulted in a 10% swing in the stock market.

It's something that fund managers and investors are going to have to pay attention to going forward.

“The global economy and financial system relies on the euro and the ECB, and the continued existence of the euro depends on the cooperation of the Eurozone countries. If the UK leaving the EU caused a 10% swing, what would a set of political events that raised questions about the future functioning of the ECB cause? Managing this risk seems to us to be an important part of managing money in this secular environment.”

A Bridgewater spokesperson didn't respond to an email request for comment at the time of publication.

Reuters first reported the contents of the memo.

--
Julia La Roche is a finance reporter at Yahoo Finance.

Read more:

John Burbank: This time of peril may herald the beginning of 'the liquidation'

Raoul Pal: The stock market is behaving the way it did back in 2000

Hedge fund titans warn of financial crisis-like market signals

How one fund manager is preparing for the market liquidity crisis

Raoul Pal: the Brexit vote is about so much more than Britain leaving the EU