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Assessing the exposure to Brexit

Andrew Miles  |  30 Jun 2016Text size  Decrease  Increase  |  

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On Friday 24 June, news broke that the British electorate had voted for Brexit, that is, to leave the European Union, or EU.

The "Leave" campaign successfully won with a majority of 51.9 per cent compared with the 48.1 per cent of the "Remain" campaign.

Prime Minister David Cameron, who spearheaded the "Remain" campaign, announced soon after the result that he would resign.

The referendum result caught investors by surprise, prompting a sell-off in risk assets around the globe.

The British pound fell precipitously against major trading partners, reaching a level versus the US dollar not seen in more than 30 years.

The FTSE 100 Index (100 largest UK-listed companies) opened down on Friday by 8 per cent, recovering to close down 3 per cent.

The more domestically focused FTSE 250 Index (the next 250 largest UK-listed companies) fared worse, posting a loss of 7 per cent at close.

Stock markets outside Europe also suffered as investors voted to leave risk assets, preferring the safety of gold and US treasuries.

As many commentators have remarked, the current situation and future for Britain and the EU is highly uncertain.

From a political and economic standpoint, there are many unknowns. With this murky backdrop, it may be useful for investors to understand the exposure of our local-rated strategies to the UK and European share markets.

Figure 1 shows the European equity exposure of our coverage list within the global equities sector. It shows the latest average exposure to the UK, developed Europe (which includes UK), and emerging Europe.

The exposures are similar to a global equity index, as measured by MSCI All Country World Index. The two managers most exposed to the UK share market are IFP Global Franchise [12160] and Templeton Global Trust Fund [5291], having 23 per cent and 16 per cent, respectively in UK firms.

The managers most exposed to the broader developed European market are MFS Global Equity Trust [4532], Stewart Investors W Worldwide Leaders [4672], and PM Capital Global Companies [6828]--all three have around 25 per cent exposure.


Figure 1: European equity exposure %


Source: Morningstar Direct™


While it is informative to look at the size of the country or regional exposure, the actual economic sensitivity of a given company can be different from its assigned domicile.

This has been shown by the divergent performance of FTSE 100 stocks since the referendum result. For example, UK homebuilders and banks have performed significantly worse than multinational pharmaceutical and consumer defensive companies.

Figure 2 shows the UK companies that appear most often in international equity portfolios, and the average and maximum weights.

At the top of the list is Unilever, a multinational consumer goods company. This firm is listed in, and does have operations in the UK and the Netherlands, but the majority of its revenue comes from outside of Europe.

Similarly, Diageo, Glencore and Reckitt Benckiser derive a large proportion of their revenue outside the UK and Europe.

International equity strategies are not the only strategies exposed to the fallout from Brexit.

Clydesdale Bank (CYB), which listed on the ASX in February 2016 after being spun out by National Australian Bank (NAB), is a regional UK bank, with purely local operations, and is arguably one of the stocks most exposed to the Brexit fallout in the S&P/ASX 200 Index.

As it is listed on the ASX, Australian equity strategies are permitted to invest in Clydesdale. Some other local stocks with meaningful exposure to Europe include: Henderson (HGG), Macquarie Group (MQG) and Wesfarmers (WES).

The weights of these stocks in the S&P/ASX 200 range between 20 basis points for Henderson to 300 basis points for Wesfarmers (as at the end of May 2016).

The market uncertainty for the UK and EU is likely to continue, and we at Morningstar continue to monitor the situation closely.

Unfortunately, the short-term damage may already be done for some of these portfolios but that doesn't necessarily mean changes to your portfolio are in order.

These strategies are diversified and invest with a long-term horizon, so a handful of poor-performing stocks or disappointing short-term returns shouldn't prompt a hasty decision.

We recommend looking at the exposures in funds you hold and reading the commentary released by your manager to make sure the exposure and strategy on offer match your preferences and risk profile.

Beyond that, it is probably best to remain calm amid the volatility, keeping a long-term perspective consistent with your investment objectives.


Figure 2: Most popular U.K. companies in international equity portfolios


Source: Morningstar Direct™


Andrew Miles is a Morningstar fund analyst.

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