A quick look at the chart below shows the overall downtrend for UK vs. EU equities over the past 3 years, fueled by uncertainty over future UK-EU trade terms and the possibility of a disorderly Brexit.
Ratio of FTSE-All Shares index over Eurostoxx Europe index (in GBP, base 100 = 1/6/2016)
We used the “Tools” feature in Butterwire to download the stock universe database as of January 2017 to first extract a list of 320 UK-listed stocks (excluding stocks with a country of risk in EM). We then ranked each of them based on their country of highest exposure, headquarters, and risk (Britain vs. Other) as well as reporting currency (GBP vs. Others).
Extract from the Jan-17 universe database downloaded available on the Butterwire platform
We then selected 70 stocks amongst the highest and lowest ranked stocks in a way that avoided large differences in size, style, as well as, to the extent possible, sector exposures. From this list of 70 stocks we created 4 equal-weight portfolios tracked from Jan-17 to Oct-19 with 0 turnover:
- Brexit (bottom 35 ranked for British exposure)
- Bremain (top 35 ranked)
- Brexit-Hedged # 1 (“High Scores” only) picking the holdings with the highest butterwire base scores from the first two portfolios
- Brexit-Hedged # 2 (“Low Scores” only) picking the holdings with the lowest butterwire base
70 stocks selected as of Jan-17 to construct 4 portfolios of 35 holdings
The performance of these 4 portfolios for the period Jan-17 to Oct-19 is summarised in the table below. Perhaps counter-intuitively given the shape of the first graph above, the Brexit-Hedged portfolio with half of the highest scores from both the Brexit and the Bremain portfolios managed to outperform both the EU market index and the Brexit portfolio. It did so thanks to Brexit holdings that provided torque when fears of a disorderly Brexit were rising, to Bremain holdings that could effectively take over when hopes of an orderly Brexit prevailed, and generally to holdings that were well supported from a fundamental standpoint and as such less liable of severe underperformance in adverse Brexit conditions. In other words, butterwire’s base score and emphasis on stock-specific fundamentals and controversies allowed to focus on researchable bets while its database allowed to find ways to neutralise the less researchable ones such as the nature of the path to Brexit.
Portfolios performance summary -- Jan-17 to Oct-19
Applying the above principle to the current environment, we have downloaded the latest stock database from the Butterwire platform and repeated the exercise, this time focusing directly on constructing a UK portfolio with equal Brexit and Bremain weights, without provocative sector or macro bets, targeting strong base scores and recession scores as well a market-like beta. The resulting 30-holding portfolio is described below.