Global Investing Hot Spots

A contrarian unfazed by Brexit morass is betting on UK stocks

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As the post-Brexit fallout continues — England's High Court ruled on Thursday the British government requires parliamentary approval to trigger the process of exiting the EU — an increasing amount of money is leaving U.K. stocks. According to Lipper, investors pulled nearly $148 million from the iShares MSCI United Kingdom ETF in the third quarter, while the the MSCI United Kingdom Index is down about 10 percent since June 23. The FTSE 100 has dropped by about 0.5 percent since the court made its announcement this morning.

Going against the herd

While some investors are running as far away from the U.K. as they can, one Toronto-based fund manager is jumping in. Matt Peden, vice president and portfolio manager at Trimark Investments, has found a number of opportunities in the country post-Brexit, in large part because valuations there have become so depressed. Depending on the sector, some high-quality companies are trading at a 10 percent to 40 percent discount from their pre-Brexit levels, he said.

Peden, who runs the four-star Morningstar-rated Trimark Europlus Fund, is playing the long game in the U.K. He knows that investing in the region might seem like a contrarian choice and he admits that some of his buys could see ups and downs in the short-term as the U.K. goes through a period of uncertainty in hopes that Brexit eventually works itself out. Over the long-term, though, he thinks the U.K. could even benefit from being on its own.

"The U.K. may actually be able to be free from some of the EU's burdensome regulations," he said. "Right now, everyone in the EU has to abide by the same laws, which are often compromised solutions, but now the U.K. will have the opportunity to negotiate their own agreements with other countries."

UK's powerful fundamentals

He said that if Brexit is successful once the process is complete, more companies could set up global head offices in the country. That's counter to what many others are saying, but he points out that the U.K. is actually a more favorable place to do business in than other countries. For instance, it has a 20 percent corporate tax rate, while America's corporate tax rate is about 40 percent, according to KPMG. It also beats out other European countries, such as France and Germany.

A favorable regulatory environment also makes it easier to open and operate a business in the U.K., he said. "It's a very market-friendly country. It fosters entrepreneurship and that's led to a number of high quality companies that are based in the U.K. and operate there."

At the moment, Peden has about 31 percent of his fund's assets in U.K.-domiciled stocks, not including Unilever, which is headquartered in the country, but is essentially an international operation. To him, the best businesses right now are domestic operations that generate most of their revenue inside the country. Those are the ones that have seen their valuations crumble, while the global companies have held up fairly well, he said.

One example is Howden Joinery, a London-based company that provides cabinets, flooring, sinks and other materials needed for a kitchen renovation. The stock is down nearly 28 percent since Brexit, but renovations continue. It may fall further if people, worried about a slowing U.K. economy, hold back spending, but that should only be temporary, Peden said. "The renovation industry tends to be more resilient even in a downturn. Kitchens could be considered an essential renovation — it's one of the most frequently used rooms in a house."

He's also keen on U.K.-based manufacturing companies that create goods inside the country, but export them elsewhere. That's because that pound has been devalued by about 17 percent against the U.S. dollar since the vote, which has made those exports more valuable. That only helps, though, if the company isn't importing too many materials from other locales. At press time, the pound was up over 1 percent on Thursday morning at 1.245 to the U.S. dollar.

The Trimark manager likes Rotok, which makes actuators, a device that plays an important part in the opening and closing of valves in the oil and gas, marine, mining and water sectors. The majority of the company's sales are in foreign currency, while their input costs are, mostly, in pounds. "Because of depreciation, when those revenues are translated back into pounds, they're worth much more," he said.

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At the moment, most of the best buys are in real estate and industrial sectors, he said, but there are opportunities across industries. The key is buying companies that generate at least 50 percent of their revenue in the U.K., have high free cash flow, can grow organically and have a higher return on capital in at least the mid-teens. "Those types of business are strong and stable companies," Peden said.

Investors will have to stomach some volatility as U.K.'s exit from the EU approaches — it's a process that could take a couple of years — but buy in now when stocks are cheap. "We're adding," Peden said. "And if prices fall further we'll continue. We're patient, opportunistic and if we see quality businesses at compelling valuations, we'll be buyers."