What investment opportunities does Brexit present?

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What investment opportunities does Brexit present?

As the March 29 deadline approaches, the topic of Brexit continues to dominate news headlines and investor thoughts.

How to navigate to and beyond this date is a critical question investors need to answer as uncertainty over a negotiated exit, no deal or a second referendum continue to divide opinion and raise the prospect of further market volatility.

ML Capital works with a number of highly experienced and skilled investment managers, who offer investors a range of strategies on the MontLake UCITS platform.

We spoke with a number of these managers to discuss how they were approaching both the Brexit issue and the broader global uncertainty and what opportunities they perceived. 

Equity managers we spoke to expressed longer term optimism once clarity around the decision emerged.

Uncertainty is currently holding back cross border M&A activity, though potentially Brexit is actually a distraction here and the elephant in the room is really clarification around a US-China trade deal.

One area of particular interest was smaller UK-listed companies. While many of these companies are international in the scope of their revenue footprint, the valuations are currently low due to the avoidance of the UK equity market by international investors.

A resolution to the Brexit debate – even a no-deal solution – will likely bring investors back, resulting in a potentially excellent entry point for investors to buy into a portfolio of businesses with strong balance sheets and excellent growth potential.

Patience will be required though, as around macro events like Brexit, there is often significant volatility. 

Alternatively, a more global mandate, that invests both long and short, allows an experienced portfolio manager to limit UK long exposure while headline volatility risk distorts valuations and seek out opportunities in other geographies.

As one manager – who has made significant profits in the UK historically but is currently keeping long UK exposure minimal – stated, resolution of the macro risk will bring the UK back into play and allow his portfolio to be positioned to take advantage of the revaluation of the winners, as well as to profit by shorting companies that will be adversely affected by the long-term impacts. 

While discretionary fund managers are patiently evaluating the potential outcomes of the Brexit debate, investors would be wise to also consider looking at investment strategies that take the emotion of the debate out of their decision-making process.

Diversification will always be one of the most powerful risk management tools in an investor’s arsenal – particularly at times of uncertain outcomes – and a systematic strategy that takes emotionless decisions will complement the discretionary views that so many investors are already exposed to.

Two strategies investors could consider to achieve this goal would be the trend-following strategies, and the short-term, volatility breakout strategies.

Both of these styles have a history of delivering positive returns in volatile environments.

In 2018, for example, the short-term, volatility breakout strategy on the MontLake UCITS platform produced double-digit positive returns in an extremely difficult year for many strategies and appears well-suited to the potential environment of uncertainty around (and beyond) the Brexit decision.

It should be noted that during the original Brexit decision, trend-following strategies were strong positive performers, even though polls were pointing in one direction and many of the subjective decisionmakers got it wrong by being in the consensus.

Trend-following strategies are also likely to be able to capture returns from the longer-term impact on financial markets, irrespective of whether there are positive or negative impacts on the economy and financial markets. 

An area of the market that investors should also be focused on is a potential post-Brexit pick-up in merger and acquisition activity which would increase the opportunity set to event-driven managers.

Uncertainty is currently holding back cross border M&A activity, though potentially Brexit is actually a distraction here and the elephant in the room is really clarification around a US-China trade deal.

Event-driven managers are inherently global investors who move where corporate activity provides them with the highest opportunity set and they will likely be very active once the global picture clears up (including Brexit) and pent up corporate structuring activity hits the market.

The overall picture is one of optimistic caution.

Investors need to look past the headlines and now is the time where diversification and a longer time horizon will provide investors with the best opportunities to navigate potentially volatile markets and reap the latent rewards when certainty, the market's best friend, returns.  

Cyril Delamare is chief executive of ML Capital