Quarterly Publication - July 2016
Brexit: The investment implications - July 2016
The consensus sentiment globally was that the UK would not vote to exit the EU, given the jump into the unknown this would represent. Therefore the world was surprised to wake on 24 June to the shock of the UK electorate doing just that. The moves in currencies and equity markets were immediate and brutal. The performance of safe haven assets such as precious commodities as well as US and Swiss government bonds was also immediately boosted as investors scurried for perceived safety in the light of this great jump into the unknown.
As referred to in the previous article, we were as surprised by the outcome of the referendum as most other market participants. This did not mean that the ensuing volatility in markets did not present a potential opportunity for clients. As always, the most important step was to remain calm and unemotional, assess the likely impact and then identify assets inevitably being mispriced in the panic that follows unexpected events.
At Coronation, we benefit from a team of over 60 investment professionals. We have detailed models on all the companies and instruments we hold, so we were able to immediately isolate all parts of the companies that would have potential exposure to the fallout from Brexit. We ran various scenarios to see what the overall impact on valuations would be. We could then compare this to the moves in the market and take opportunities to invest where there was a clear discrepancy between what the market was pricing and what the actual impact would end up being. To be clear, this is not a simple process of buying the assets that have fallen the most; the end outcome for the UK and Europe is not clear and risks in certain valuations have increased.
An example of our approach was illustrated by our holdings in two large listed property companies in the UK. Intu and Capco, which are dual-listed in SA, fell 26% and 35% respectively in the days following the referendum. We bought a lot of Intu as we are very comfortable with its forecast for expected rental income, given the defensive nature of its shopping centre portfolio, which is predominantly based in regions which will be unaffected by the Brexit vote. We also do not believe that credit markets will freeze like they did following the global financial crisis, and expect that capitalisation rates will remain fairly stable as the Bank of England is likely to cut interest rates further. With Capco we have been more circumspect. While half of its valuation is represented by the retail-focused Covent Garden (which should do even better given increased tourism from the weaker pound), the other half of its valuation is far more speculative, influenced by the demand and pricing levels for residential property in the City of London, which is likely to feel the pain of Brexit more keenly.
We have increased our holdings in two other dual-listed counters significantly following the referendum. Old Mutual fell sharply in line with many other UK insurers, despite the fact that the majority of its operations are domiciled outside the UK. The company is in the process of unbundling its core components and re-domiciling most of these assets back in SA. We do not expect the UK operations of Old Mutual to be that affected by Brexit, given that it is a UK wealth business serving predominantly UK citizens. As roughly 25% of the Old Mutual valuation is UK-based, we would have expected at most a 2.5% decline in its value with the 10% fall in the pound. Instead the share fell 14%, clearly an over-reaction.
Mondi has virtually no operations in the UK; all its operations are domiciled in Western and Eastern Europe and SA. Other than some potential spill-over from weaker European growth into demand for its packaging products there should be no impact at all from Brexit on its business. The slightly weaker euro will actually benefit Mondi’s export business. Despite this, Mondi’s share price fell 10% following the referendum, presenting a clear opportunity.
A number of other companies with very little or no UK exposure also fell on the day as a result of general risk sentiment. Anglo American, MTN and Steinhoff all fell between 10% and 12%, presenting good buying opportunities as these businesses’ fundamental values were entirely unaffected by the Brexit decision and their share prices merely reflected investor panic.
In the flight to safety, some of our other holdings have performed extremely well amid the panic. Our holding in British American Tobacco and our platinum shares were the big beneficiaries of money moving into safe havens. To the extent that the market has priced in a lot of good news here, we reduced some of these holdings to fund new investment ideas.
Markets are full of uncertainty. Unusual events will play out time and time again, often in an unpredictable fashion. As managers of long-term capital, our key strength is having the knowledge and depth of analysis to be able to take calm and rational decisions, often against the sentiment of the day. In times like these, some of the best investment decisions are made.