BREXIT AFTERMATH...

BREXIT AFTERMATH
http://rogermontgomery.com/brexit-aftermath/#more-19177

In a previous post, I outlined our thinking in respect of positioning the portfolio ahead of Brexit, particularly in regards to Henderson Group (ASX: HGG), which is the most direct exposure we have to the UK.

With the result of the vote now in, and the position having gone against us, it is timely to reflect on the original decision, and to determine what, if anything, could have been done better, and where to from here.

When we did our previous analysis, we constructed a probability tree that mapped out alternative scenarios for the vote, and alternative scenarios for market conditions in Europe, with an ‘exit’ vote increasing the likelihood of difficult times ahead for the UK and Europe. We assigned probabilities to the different scenarios and calculated a probability weighted average, which by our numbers showed a value for Henderson neatly above the prevailing share price.

Post the vote, the HGG share price has suffered a painful share price decline. However, we knew this was likely in the event of exit, and the current trading price is in line with what we anticipated for that scenario, so our analysis was on the mark in that respect. Recognising this possibility, we kept our position sizes small to limit the downside, and so the outcome will not leave much of a mark on the Fund’s track record.

Importantly, while we anticipated that price could decline by this amount, we did not – and still don’t – think that the impact to underlying value is as great.

With the benefit of hindsight, our view on the ‘exit’ scenario is not much different to what it was before the vote. The only thing that has changed is that this scenario is now the reality, where previously we had judged that a ‘remain’ outcome was more likely.

Our assessment of the likelihood of ‘remain’ was based on a range of data points, including final opinion polls, betting odds and estimates provided by experts, all of which pointed in the same direction. One astute reader, Mishkel, highlighted a concern with the veracity of betting odds in this instance, but even taking that into account we assessed ‘remain’ as the more likely outcome. It is the nature of probability that unlikely outcomes do sometimes arise, so we can’t tell if our estimate of the probabilities was faulty. If a roll of the die throws up a ‘6’, that doesn’t mean it was reasonable to expect a ‘6’ before the event.

So with the benefit of hindsight, our analysis looks like it was sound, even if the result went against us. If we approach similar problems the same way over a long stretch of time, we will certainly have some go against us, but it is reasonable to expect that we should win more than we lose.

The challenge now is to determine what has happened to the value of HGG, and where it now sits relative to the share price. This is by no means easy, but our assessment is that the share price now factors in a very dire scenario in terms of FUM flows and market returns. While the vote has certainly impacted on these things, it does not appear to us that the impact is as dire as implied in the current share price. Accordingly, we view the current share price as a potential long term opportunity.

There is more water to flow under the bridge before we have clarity on the path forward for the UK and Europe, but at this stage we see more upside than downside, and have added slightly to our holdings.

Tim Kelley is Montgomery’s Head of Research and the Portfolio Manager of The Montgomery Fund.