Jamie Clark

Brexit – it’s better to arrive than to travel

Jamie Clark


Given the differences between UK and EU negotiators and the coming spate of Brexit deadlines, it feels timely to review the import for the portfolio.


We run a Macro-Thematic investment process. This requires that we identify durable macro trends and invest in those companies likely to benefit. Such trends don’t exist in a vacuum and are prone to short-run influence from real-world events.


The Brexit referendum is the starkest instance of this. The shock of a Leave vote overrode the case for several key themes. This was most severe for the domestic cyclicals and financials of our Infrastructure Spending and Population Ageing themes, as investors discounted a Brexit blow to UK gross domestic product.


Time has passed and markets have regained poise, but the present standoff in Brexit negotiations raises the spectre of a repeat sell-off in UK equities.


How concerned should we be and have we taken action?


The first point to make is that we are long-term, thematic investors. Reordering the portfolio in anticipation of a singular event isn’t part of our approach. It would be short-termist and may leave the Fund on the wrong side of a binary trade.


But what to make of Brexit political noise? We’d suggest that ‘noise’ is the operative word.


Amongst market strategists and financial journalists, there is a cottage industry devoted to forecasting financial market outcomes on the strength of political newsflow. Brexit is one such example. But there’s a snag: research tells us that predictions in this domain are just narrative, offering little practical insight into the future [1]. 


What’s more, forecasting asset prices on such unreliable grounds serves only to compound an already tricky exercise. In this regard, we see parallels with the Roman practice of haruspicy: both offer no predictive value and are liable to make a mess!


So what do we know and how have we applied it to our portfolios?


The most concrete point to flow from Brexit is that UK equities are cheap in aggregate. As is understood, the referendum triggered downgrades to estimates of the UK’s economic prospects and a parallel de-rating of UK shares. The FTSE All-Share’s prospective price/earnings multiple has fallen more than four points since mid-2016 and presently sits at 13.3x.


This is an opportunity. In recognition, we have reduced our exposure to highly-rated, lower-yielding US equities, whilst increasing our allocation to the UK. Our weighting to the US has been cut by 50% in the last two years and we’ve captured a meaningful pick-up in dividend yield.


Delve beneath headline equity indices and you’ll notice that the real opportunity is more specific.


The referendum gave an immediate fillip to UK equities with non-sterling earnings: consumer staples, tobaccos and pharmaceuticals thrived.


Brexit was harsher on UK companies with material domestic exposure. Of the worst performing UK large-caps on the day after the vote, UK sales averaged more than 80% of total revenues. Housebuilders, life insurers and banks bore the brunt.


It’s no revelation, but the ratings of such companies remain handicapped by Brexit. The above chart shows the FTSE Local UK Index – an index of large and mid-cap companies which earn over 70% of their sales in the UK – relative to the FTSE 100. We regard this as an opportunity on grounds of valuation and have made efforts to exploit this.


Life insurer Legal & General is now the Macro Equity Income portfolio’s largest holding, having been increased in recognition of 10% compound earnings growth. We’ve added St James Place because of its strong record of AUM (assets under management) and cash earnings growth in the midst of the financial advice gap. Lloyds Banking Group has been initiated in light of its capacity to generate capital and the gearing it offers to UK economic expansion. We also now own hard-landscaping business Marshalls due to the UK’s infrastructure spending deficit.


There is, however, a broader point to make. The gulf between market rating and operational performance means many of these companies are best characterised as ‘value’. We would expect such businesses to outperform as clarity on Brexit is attained, economic conditions improve and interest rates normalise.  As such, the UK is the epicentre of the global value trade and our portfolios are positioned to exploit this.


Sceptics will argue that the consequences of Brexit are unclear on any horizon and, as such, cheap stocks must remain cheap indefinitely. But this ignores the effect of expectations on valuations.


The referendum has cast a shadow over the UK for more than two years. By now investors should be well-versed on the spread of probable outcomes. By way of example, of the nine Inflation Reports published by the Bank of England since the referendum, there have been 153 references to Brexit or Leave. Of these, roughly 80% have been couched in terms of risk, or uncertainty. The accompanying de-rating of the FTSE All-Share Index (from a forward price/earnings of over 17x to 13.3x) suggests markets have gone a long way to discounting this.


The defining insight of behavioural finance is that we feel losses more keenly than profits. Given the weakness of UK-centric shares and two years of Brexit navel-gazing, our sensitivity to loss means the worst could well be in the price.


To invert the well-known expression, it may be that it’s better to arrive than to travel.


[1] Philip Tetlock, Expert Political Judgment, 2005

For a comprehensive list of common financial words and terms, see our glossary here.


Key Risks 
Past performance is not a guide to future performance. Do remember that the value of an investment and the income generated from them can fall as well as rise and is not guaranteed, therefore, you may not get back the amount originally invested and potentially risk total loss of capital. Investment in Funds managed by the Macro Thematic team involves foreign currencies and may be subject to fluctuations in value due to movements in exchange rates. The Fund’s expenses are charged to capital. This has the effect of increasing dividends while constraining capital appreciation. The performance of the Liontrust GF Macro Equity Income Fund may differ from the performance of the Liontrust Macro Equity Income Fund and is likely to be lower than its corresponding Master Fund due to additional fees and expenses.
The information and opinions provided should not be construed as advice for investment in any product or security mentioned, an offer to buy or sell units/shares of Funds mentioned, or a solicitation to purchase securities in any company or investment product. Always research your own investments and (if you are not a professional or a financial adviser) consult suitability with a regulated financial adviser before investing.
Tuesday, October 2, 2018, 10:27 AM