How to position your investments for Brexit
With Britons about to cast their vote on leaving the European Union, many investors are asking how they should position themselves in the event the ‘yes’ vote gets up. As fund managers, it’s a question we’ve been forced to address head on.
Should Britain decide to leave, there are expected to be significant consequences for the British economy and equity market and the value of the pound. Not to mention potentially wider consequences for the stability of the EU and Europe generally.
From our perspective, the most acute consideration has been in respect of Henderson Group and BT Investment: two fund managers we hold that derive much of their value from European operations, and which face considerable risk in the event of a Brexit vote.
So, what have we done about this?
An easy response would be to avoid exposures like this altogether. The risk of loss is always unwelcome, and staying away from investments that present this risk might seem like a sensible strategy. However, taking the easy way is not what we have done.
As equity investors, it is not our job (nor is it possible) to avoid all risks. Our job is to avoid the silly ones. An important part of what we do is working out which of the risks we might take are best rewarded with potential upside, and to actively pursue those risks. Quite often, it’s the risks that people are most concerned about that offer the best balance of upside and downside.
In the case of Henderson, the share price has been significantly impacted by uncertainty, and at some point that share price becomes compelling to a rational investor. Our job is to try to work out whether that point has been reached.
This is by no means easy. We can identify a useful analytical framework in the form of a probability-weighted valuation, which considers the different possible outcomes (eg leave or stay), the value that we might ascribe to Henderson under the different outcomes, and the probability attaching to the different outcomes, to arrive at a weighted valuation estimate. However, not all the inputs for this calculation are easy to estimate.
We have a good sense of the value of Henderson under a ‘business as usual’ scenario, and we can make an informed assessment of the probability of Brexit. On this second point we note that while the polls show a very close race, the betting odds available in the market suggest a much stronger likelihood of a ‘remain’ vote. Given that the betting odds are set by people voting with real money and with full awareness of what the polls say, it makes sense to favour the latter.
What we can’t easily estimate is the value consequences of a ‘leave’ vote, and the potential additional downside arising if a leave vote triggers broader economic instability across Europe. With no reliable way to estimate these impacts, the only option is to try to be conservative, and to factor in a devastating loss of value under these scenarios.
When we work through the numbers we conclude that Henderson offers an attractive balance of risk and reward when compared with the current set of opportunities available in the market, and that means it is rational for us to hold a position. Given the downside risk it does not make sense for us to hold a large position, but it does make sense for us to hold some.
So that is what we’ve done.
Later this week we will know whether this decision has been a success or a failure. It could easily go against us, but in the long run we are confident that analysing the numbers and investing rationally will get better results than taking the easy way out.
Tim Kelley is Montgomery’s Head of Research and the Portfolio Manager of The Montgomery Fund. To invest with Montgomery domestically and globally, find out more.