How to buy equities after Brexit

22nd September 2016 by Darius McDermott

Almost three months on and the UK stock market has soared since the Brexit vote, up more than 10% from June 241. It’s been a nice morale boost amid some fairly gloomy predictions for Britain’s future, not to mention a welcome lift to returns for investors.

Market reactions so far have been mostly driven by sentiment, however. We’re yet to see any tangible action taken towards Brexit, so key questions like access to the European Single Market and London’s future as a financial services centre loom. Negotiations are surely due to kick off soon, and I think we can expect uncertainty to re-emerge once the talks begin and trade-offs become a reality.

For most investors, a UK equity holding will remain the cornerstone of their portfolios, but the way you play the sector could make a big difference to your returns over the next few years.

What caused the bounce?

Let’s not forget that our stock market posted some fairly tremendous falls in January and February, when the date for the referendum was set. While the market had recovered from these lows even before the vote, Brexit uncertainty arguably caused UK equities to perform weakly throughout the first half of this year. This may have given the bounce a bit of extra ‘oomph’.

We should also look at the divergent performances of large caps (the UK’s largest listed companies) versus small and mid caps post-vote. After initial turbulence, large caps took off. Many earn the majority of their revenues overseas, and so as the pound tumbled their international earnings became more valuable when converted back into sterling.

Funds holding these kinds of companies immediately did well. The Elite Rated Evenlode Income was one such success story. Manager Hugh Yarrow has a concentrated focus on high quality, UK-listed multinationals across diverse industries and he was positioned to outperform in the event of a Brexit. I think Hugh’s strategy will continue to shine in the current environment, albeit possibly at a more temperate pace now that is has posted such significant gains.

On the other hand, medium and smaller businesses, whose fortunes are typically more closely tied to the domestic economy, struggled. The International Monetary Fund lowered the UK’s economic growth outlook for 2016 and 2017 and many economists were even predicting recession.

But the Bank of England (BoE) came to the rescue, lowering interest rates to try to boost economic growth and strongly suggesting there could be more cuts to come. This provided some reassurance that our economy would be supported through the Brexit transition. Mid- and small-cap stocks have now seen decent recovery gains too.

Where to invest?

Many of the fund managers I speak to are starting to suggest the ‘easy money has been made’ out of the Brexit bounce. We’ve been in the ‘best of both worlds’, from a stock market perspective, with the BoE stimulus and no real change to demand. The ‘downside risks’ are yet to come through.

For this reason, I would particularly suggest that now is not the time to buy a market tracker. The recent surge is making the indices look expensive and you risk buying right as we are on the cusp of renewed volatility. Instead, I’d recommend a few carefully chosen active funds, whose managers will be looking to exploit this volatility, rather than simply being taken for the ride.

Mark Martin, manager of the Elite Rated Neptune UK Mid Cap fund, sees many opportunities emerging in the mid cap space. For example, he believes we will see increased merger and acquisition activity as some of the UK’s best medium-sized companies start to look ever-more attractive to international buyers, encouraged by the weaker sterling. And he makes the point that there are many UK mid caps with international exposure and an international cost base – a kind of double-whammy financially right now. His fund earns just under 50% of its revenues in the UK2 and it has outperformed the market strongly since the vote3.

The Elite Rated Woodford Equity Income has also risen remarkably since the Brexit vote. Manager Neil Woodford’s ever-prescient focus on quality companies and astute understanding of the macroeconomic outlook has seen him steer his investors comfortably through many a stormy sea and stands him in good stead this time round.

1FE Analytics, FTSE All Share, TR in GBP, 24/06/216–18/09/2016

2Neptune Investent Conference 2016, Mark Martin, head of UK equities, speaking 06/09/2016

3FE Anlaytics, FTSE All Share vs Neptune UK Mid Cap, TR in GBP, 24/06/216–18/09/2016

Past performance is not a reliable guide to future returns. You may not get back the amount originally invested, and tax rules can change over time. Darius’ views are his own and do not constitute financial advice.