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Brexit Hedge Paying Off

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Brexit Hedge Paying Off

Last Friday was an historical day. In a surprise result last Friday, a majority of Britons backed the campaign to Leave the European Union. After 4 decades the UK will now embark on a 2-year journey towards formalising its independence from the European Union.

Unsurprisingly, the Brexit decision triggered a sell-off in equity markets around the world and the British Pound was hammered. The Montgomery Global Fund and Montaka funds were well prepared to protect the downside for our clients.

As I completed my blog post “Brexit Hedge” last Thursday afternoon the polls, totes and markets were backing a Remain win and the British Pound traded up to around US$1.50. By Friday morning Sydney time this had changed dramatically. First votes were being counted and it was becoming clearer that Leave was on a path to victory. The British Pound reacted quickly and dropped quickly to around $1.35, a loss of 10 per cent in a matter of minutes. When UK stock market trading opened on Friday morning London time equity prices gapped down by more than 7 per cent. Over the next 2 days, world equity markets sold off by 7 per cent (measured in US dollar terms, the result would have been worse if translated into Australian dollars). According to the Wall Street Journal and Chicago-based Hedge Fund Research equity hedge funds fell more than 2 per cent on Friday alone. Montaka, our global long/short fund did not. Rather, it protected client capital. MGF outperformed the markets.

The British Pound has fallen off a cliffScreen Shot 2016-06-29 at 4.40.07 PM

The UK equity market gapped downScreen Shot 2016-06-29 at 4.40.34 PM

World equities sold offScreen Shot 2016-06-29 at 4.41.01 PM

Last week I described 3 tools we had at our disposal in order to manage the event risk surrounding the Brexit vote. In addition, the Montaka fund benefitted from its unique structure in 2 ways. Firstly, Montaka was positioned with a net market exposure just above 40 per cent. At times when equities decline in unison over short periods this low exposure to the overall market typically dampens the downside impact on Montaka. Secondly and in my view more importantly, Montaka’s short portfolio enables clients to profit from declining share prices in deteriorating businesses. When sentiment is positive and concern a scarce commodity, the share prices of challenged businesses don’t always go down. In periods of uncertainty and distress however these vulnerabilities may come to the fore in investors’ collective psyche. This happened on Friday and again on Monday this week, and our short portfolio was positioned to benefit as the stock prices of low quality businesses fell considerably.

MGF was also well positioned to weather the Brexit fallout in two ways. Firstly, MGF held around 22 per cent of its assets in cash. In declining markets this cash balance holds its value, much unlike stock prices. Secondly, we own a portfolio of high quality businesses. While they aren’t immune to broad market downturns in the very short run, their strong attributes were recognised by the market even as other stocks traded off much more heavily.

While we are pleased with the performance of our portfolios over a very testing time this past week, our focus is now squarely on the future. No sense driving forward while looking in the rear-view mirror. Given our low market exposure to the market in Montaka and the significant cash balance we hold in MGF, we now have the benefit of being able to use this as a platform to add to new and existing positions at much more appealing levels. We can also close out some or all of the profits from our short positions. In fact, we had anticipated the possibility of being in this position ahead of time, so we’ve already started to take advantage of these opportunities for our clients.

Christopher Demasi is a Portfolio Manager with Montgomery Global Investment Management. To invest with Montgomery domestically and globally, find out more.

Christopher is a Portfolio Manager at Montgomery Global Investment Management. Christopher joined Montgomery in January 2015 after spending more than four years at LFG, the private investment group of the Lowy family, where he was most recently a senior member of the research team based in New York. Prior to this Christopher worked as a research analyst at One East Partners, a hedge fund based in New York, and as an investment banker at Goldman Sachs in Sydney.

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This post was contributed by a representative of Montgomery Investment Management Pty Limited (AFSL No. 354564) and may contain general financial advice that is prepared without taking into account your personal objectives, financial circumstances or needs. Because of this, before acting on any of the information provided, you should always consider its appropriateness in light of your personal objectives, financial circumstances and needs and should consider seeking advice from a financial advisor if necessary.

7 Comments

  1. Well done all-Brexit has a long way to so you will be kept busy with more of the same.
    Glad I am with you
    Cheers

  2. So you had 60% long, 20% short and 20% cash. Why not have
    70% long 30% short ? Woundnt being fully invested work better in the long
    run, dont increase the number of positions, just spread it out of current ones .
    So if REA was a 6.4% of the portfolio just increase to about 7% and so on throughout. So the extra 20% invested would give the return of the overall fund, compared to cash.

    • Christopher Demasi
      :

      In hindsight, if everything had gone up, it always would have been better to put more in. Unfortunately we cannot know in advance. Having the ability to invest both long and short gives us additional tools to protect the downside and generate absolute returns. The amount of exposure taken is a function of the available opportunities from bottoms-up analysis, stock by stock. It’s not a market-wide macro call. Cash and lower net exposure insulate from market wide down movements and also provide dry powder for new opportunities.

  3. stephen colless
    :

    Well done Montgomery team. This is reason you handle my investments and not me as i would only make mistakes. As history has proven.

  4. Thanks Chris.

    Any thoughts on Henderson – i.e. how will Brexit impact, and has the substantial fall in price over the last week created buying opportunities?

    Joe

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