Brexit: what it means for Finsbury Growth & Income

London Stock Exchange © Getty Images
LSE should see significant upside if politics allow its merger with Deutsche Börse to proceed

A large number of MoneyWeek readers hold the Finsbury Growth & Income Trust run by Nick Train (it is in our investment trust portfolio). With that in mind I thought you might like to see Nick’s thoughts on the volatility in markets over the last few trading days, and on how his fund has coped.

He has, he says, bought more shares in the fund and it remains in the portfolio (subscribers will see a review of the portfolio as a whole in the magazine in the next few weeks). Nick’s piece – written yesterday – is copied below.

Things are moving so quickly across markets and for LT’s UK strategy that it is hard for me to be clear about just what has happened to date and why, much less what may be to come. But a few things are clear.

The Finsbury Growth & Income Trust (FGT) was having a poor second quarter until the day of the referendum, with June itself particularly weak. I ascribe this relative weakness much more to specific stock/company issues than to the vote.

Performance recently had been hit (understandably so) by disappointment about the results of key holdings Daily Mail and Burberry. Diageo, too – a major position – has not proven as “defensive” or resilient as its industry classification might suggest, because of concerns that its drop in earnings, that began two years ago, will not end any time soon.

Then there is the 7% position in London Stock Exchange. In contrast to these others, LSE has traded absolutely as a Brexit chip, with significant upside if the politics allow its merger with Deutsche Börse to proceed, and some downside (although much lower in our opinion) if not. No surprise that LSE had detracted from our performance in the run-up to the vote.

The second thing that is clear is that the strategy proved very resilient on the day of the Brexit result. It looks as though there may have been a roughly 3% relative gain on Friday 24 June alone.

The drivers here are obvious: companies with low exposure to the UK economy did well, especially those with “defensive” characteristics. We have estimated in the past that at least 75% of the earnings of our portfolio come from outside the UK – emphasising the global nature of many of the franchises we hold. This is a higher proportion than for the FT All Share Index, which has more exposure to domestic UK earnings (although still less than many realise). So Friday actually saw share price gains for our three biggest holdings – Unilever, RELX and even Diageo (amounting to about 30% of our fund’s net asset value alone). They are all global companies, with reassuringly predictable earnings.

In addition, Burberry and Pearson (about 9% of the total portfolio) also gained, as the international nature of their business outweighed investor concern about their short-term earnings.

Elsewhere, the non-UK stocks we own – Heineken, Mondelez, Dr Pepper, Remy and Kraft – all did relatively well, in part because of their non-sterling domiciles and their “defensive” qualities.

What hit our performance on Brexit day – notwithstanding the above – was our UK financials, notably Hargreaves Lansdown and Schroders, which both had double digit falls. Daily Mail was weak too – as a more UK-exposed company. While some UK banks and other financials fell by up to 20% it was notable that LSE was “only” down around 8%. Its share price was supported by the joint announcement from LSE and the Deutsche Börse that their merger remains on track – but perhaps also by the recognition that LSE’s earnings are not as vulnerable to UK economic activity as a domestic mortgage lender, for example.

Of course, we don’t know what happens next. But we take an optimistic view. We expect the UK to be able to reach an acceptable trade agreement with our friends on the continent, while at the same time increasing the number of other important economies with whom we will be able to trade more freely. This should be good for the UK economy and enhance the long run earnings power of our portfolio companies.

We very much hope this is the outcome of the inevitable period of uncertainty and disruption which looms. On that point we urge all our clients to remember how critical the “long term” is for the valuation of UK equities and not to obsess too much about short term earnings disruption. The duration of an equity asset can be roughly calculated as its dividend yield divided into 100. The UK stock market has a dividend yield today of  about 4%. This means, whether they know it or not, investors in UK stocks are taking a 25-year view at least of the earnings power of the companies they are invested in. The success or failure of UK companies and the effect of Brexit on them is already (and correctly so) being judged over decades, not over a few quarters or half years.

In fact, on a 25-year view we expect the significance of this vote for the earnings and share price performance of UK companies will be relatively minor. Far more important will be the UK’s participation in the wealth creation promised by new technology and, still, the emergence of billions of new consumers into the global market place. We hope and certainly intend FGT’s portfolio will offer exposure to these wealth drivers.

The portfolio has a modest amount of cash today – Sunday 26 June. Unless we find ourselves facing significant share buybacks next week we intend to invest all that cash, most likely into existing holdings. Schroders on a dividend yield of nearly 4% and net cash on its balance sheet looks very attractive to us. The LSE too, where we can see that politicians across Europe and the UK may be keen to allow the merger to go through in order to demonstrate continuing goodwill.

I bought a few more FGT shares for myself on Friday.