In the lead-up to the referendum on the UK’s continued membership in the European Union (EU), certain British bookmakers were offering strong odds on bets the UK would opt to exit, anticipating an approximate 25% probability of a leave win.1 At the same time, both sides were running neck-and-neck in the polls,1 rationally implying around a 50% chance of a leave vote result. This is an obvious example of a mispriced bet.
Investing is a much different endeavor, of course, involving detailed analysis of company balance sheets and fundamentals — not opinion polls. But one of the factors that’s critical to analyze is whether a stock is undervalued or overvalued. The market occasionally misprices stocks, which could affect whether or not a good company is also a good investment.
My role is to track and evaluate the various opportunities the market is offering and pass/sell when the probability of excess returns is not in our favor and to purchase when the expected return on investment is favorable. Consequently, this process leads to the sale of securities and an accumulation of cash at times when the vast majority of investment opportunities are trading at valuations in excess of their respective intrinsic values (the value necessary to deliver the investor a fair return). Conversely, when market conditions create ample opportunity to obtain high-quality businesses at material discounts to fair value, the process will typically lead to a deployment of cash or a reallocation from fair-valued to discounted securities.
Looking for opportunities when others are selling
What does all this mean as a portfolio manager in the context of Brexit? After the vote, markets experienced a panic-driven sell-off following the unexpected outcome that wasn’t adequately factored into the prices of stocks. Consistent with our fund’s approach, we are looking for opportunities to shift assets from higher-priced European equities to more attractively priced UK equities in Invesco International Companies Fund.
Looking toward the long term for Europe
I believe the long-term future of the UK outside of the EU is bright. In my view, the country has the opportunity to shed the burdensome regulation and bureaucracy of the EU and solidify its status as a highly productive, rationally regulated and diplomatically governed economy with low unemployment levels, similar to the position now enjoyed by Switzerland.
In contrast, I believe countries such as France, Italy, Portugal and Greece are now increasingly vulnerable in the aftermath of the Brexit, as the long-term stability of the union, and therefore the notion of a readily accessible financial backstop to such countries, becomes fraught with doubt.
Moreover, the UK citizens’ desire to leave the EU is not an isolated instance. A majority of people surveyed in Greece, France and Spain hold unfavorable opinions of the European Union, calling into question the long-term stability of the union in its current form.2
In the immediate aftermath of the Brexit vote, the market may have once again mispriced the value of certain assets. Perhaps the euro should have been declining materially relative to sterling, instead of what occurred following the vote, which was the opposite. After all, if the UK economy is to become much like Switzerland’s, one could conceivably look to the history of the Swiss franc to gauge the long-term trajectory of Britain’s currency.
Invesco International Companies Fund: Outlook for the UK
It’s not surprising that through our team’s research process of identifying and vetting well-managed companies that offer sustainable competitive advantages, earn high returns on capital, generate strong free cash flow and benefit from above-average organic growth prospects, we have historically found a disproportionate number of such businesses in the UK and Switzerland. Both countries have market-oriented policies, reasonable taxation, limited bureaucracy, pragmatic regulation and fair legal systems — all of which garner talented and motivated citizens, foster innovation and entrepreneurship, and can result in high rates of growth, promoting investment. These attributes give the Invesco International Companies Fund team a high degree of confidence in our belief that the UK will enjoy long-term economic success outside of the European Union.
1 Source: City A.M., June 22, 2016
2 Source: Pew Research Center, June 7, 2016
Read more about Brexit from our experts.
Excess return refers to excess return generated by one index, strategy or investment factor over another.
Fair value is the estimated total value of a company’s assets and liabilities.
The risks of investing in securities of foreign issuers, including emerging market issuers, can include fluctuations in foreign currencies, political and economic instability, and foreign taxation issues.
The performance of an investment concentrated in issuers of a certain region or country is expected to be closely tied to conditions within that region and to be more volatile than more geographically diversified investments.
Many countries in the European Union are susceptible to high economic risks associated with high levels of debt, notably due to investments in sovereign debts of European countries such as Greece, Italy and Spain.
Derivatives may be more volatile and less liquid than traditional investments and are subject to market, interest rate, credit, leverage, counterparty and management risks. An investment in a derivative could lose more than the cash amount invested.
Stocks of small and mid-sized companies tend to be more vulnerable to adverse developments, may be more volatile, and may be illiquid or restricted as to resale.
Growth stocks can perform differently from the market as a whole, as growth stocks tend to be more expensive relative to the issuing company’s earnings or assets compared with other types of stock.
Investments in certain countries in the European Union are susceptible to high economic risks associated with high levels of debt, such as investments in sovereign debt of Greece, Italy and Spain.
Preferred securities are subject to issuer-specific and market risks applicable generally to equity securities.
The fund is subject to certain other risks. Please see the current prospectus for more information regarding the risks associated with an investment in the fund.
The information provided is for educational purposes only and does not constitute a recommendation of the suitability of any investment strategy for a particular investor. Invesco does not provide tax advice. The tax information contained herein is general and is not exhaustive by nature. Federal and state tax laws are complex and constantly changing. Investors should always consult their own legal or tax professional for information concerning their individual situation. The opinions expressed are those of the authors, are based on current market conditions and are subject to change without notice. These opinions may differ from those of other Invesco investment professionals.
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