Lessons from Brexit market winners is don’t panic

LONDON : The best-performing mutual funds avoided explicit directional bets on the outcome of last month’s UK vote to leave the European Union, sitting out the volatility by latching on early to large, defensive, dividend-paying blue chip stocks.

This strategy has, so far at least, been the big winner post-referendum as UK stock markets stabilise after the sharp downdraft in the aftermath of the vote.

More ‘active’ fund managers, who choose stocks with a view to delivering better returns than benchmark indexes – charging higher fees for this – have struggled this year. Only a quarter of UK-focused equity funds have bettered the performance of the FTSE 350, a broad gauge of British stocks comprising large and mid-cap companies, data from fund tracker FE Trustnet shows.

For returns over the past month that capture the market’s swings following the Brexit vote, however, that ratio has worsened significantly. Only one out of every eight funds have beaten the index over that period, suggesting many were caught wrong-footed.

Hugh Yarrow, whose fund comfortably beat peers on June returns, stuck to his large holdings in “unfashionable” stocks like Unilever and Diageo — the same stocks that panicked investors rushed into seeking shelter from the selloff.

“The global economy is fraught with event risk. There have been plenty over the years – Greece, the Scottish referendum. There will always be uncertainties,” said Yarrow, but a focus on industries that do not rely on debt and on companies with resilient revenues and the ability to grow dividends offers the best shield against choppy markets.

Stocks plunged following the vote in one of the heaviest trading days in the UK since the financial crisis of 2008. Sterling collapsed to its lowest level against the dollar in more than three decades and British and European banks lost more than a fifth of their value.

The snap back, particularly in shares of large, UK defensive stocks in which Yarrow has large positions, however, was equally sharp. Shares of long-established global healthcare and food and beverage giants had recovered all their post-referendum losses in the following week.

For Yarrow, who works from a converted barn in rural Oxfordshire and cites legendary value investors Warren Buffett and Benjamin Graham as influences, the market reaction after the Brexit vote was a vindication of trading infrequently, buying quality companies and avoiding investment fads.

Diageo and Unilever, the fund’s top holdings, are up 20 percent and 14.3 percent respectively from lows hit after the referendum results and among the biggest drivers for the FTSE 100’s recovery since the referendum.

Both shares have easily outpaced the FTSE 100’s performance this year.

Yarrow manages the 823 million pound ($ 1.08 billion) Evenlode Income fund, now the top performer over one and three years out of 265 peers in the Investment Association’s ‘UK All Companies’ sector. The fund is up 8 percent this year compared with a 3 percent decline for its sector.

CASHING IN

The second-best performer over the past month adopted a similarly conservative stance that he didn’t alter either side of the vote.

Even though interest rates are near record lows, Michael Ulrich, co-manager of the 1.7 billion pound JOHCM UK Opportunities fund was happy to hold a fifth of his fund in cash, the maximum allowed limit for U.K. funds, while the rest was largely invested in high-dividend, diversified blue-chips.

“Our view was that the world is an unstable place before the vote because of levels of debt, asset values and the policies of central banks,” Ulrich says. “If you have a view the system is already broken, you have to have a portfolio that is going to be resilient when challenges come.”

In addition, large positions in diversified companies like British American Tobacco, up 14 percent post-referendum, and publishing group RELX, up 17.4 percent, have seen his fund move to second in the league table over one year.

Now, a month after the referendum, both managers face a dilemma: whether to sell positions in newly-expensive stocks they have often held for years.

Ulrich’s fund has shifted allocations away from defensive, overseas-earners like Unilever and British American Tobacco and has bought shares in the past month in some UK-focused companies which bore the brunt of the selloff.

The fund’s latest monthly commentary to investors mentions Capita, Travis Perkins, Next, Morrison’s and Tesco as purchases in the days following the referendum.

For Yarrow, finding the attractive balance between dividend yields today and dividend growth in the future remains the winning formula.