Skip to Content

INVESTMENT GEMS SHINE BRIGHTLY THROUGH BRITAIN'S GREY CLOUDS

August 2016

Myooran Mahalingam, Portfolio Manager, Global Equities, MLC

The Brexit outcome was certainly not one investors were expecting. And as the UK is a significant exporter to, and importer from Europe, the impact this will have on the nation’s economic growth is not yet fully understood. However, as Myooran Mahalingam explains, this is a timely reminder that share performance can be quite different to underlying economic performance and active stock selection can help investors uncover value.


A global trader, not just a European trader

Investors were initially quick to flee the UK share market, but bucking the trend of other European share markets, the UK FTSE 100 is now trading higher than it was before the Brexit vote, in local terms (as at 3 August 2016). Much of this performance can be attributed to large UK-based exporters like Shell or Glaxo, who are benefiting from the fall in the currency. However it’s important to look at the market from all angles. And an interesting perspective is to decompose the market by size and sector.

Chart 1 shows that UK large companies only derive 24% of their revenue from the UK itself, meaning 76% of their profits come from other countries. And in fact, 58% of large cap revenues come from countries outside of the European Union. This means these large, multi-national companies are more immune to a slowdown in the UK’s underlying economy. On the other hand, you can see UK mid and small-caps derive their profits predominantly from the UK and Europe, meaning they’re more exposed to an economic downturn in either of the states.

Chart 1: Size and regional exposures of UK companies - large caps, materials and health care derive marginal profits from their home economy

Size and industry

UK

Europe

Rest of world

Large

24%

18%

58%

Mid

51%

17%

32%

Small

55%

13%

32%

Investable Market Index (IMI)

32%

17%

51%

 

 

 

 

Materials

5%

19%

77%

Health care

6%

20%

74%

Energy

13%

20%

67%

Info tech

22%

22%

56%

Telecoms

35%

37%

28%

Consumer staples

44%

15%

41%

Industrials

45%

13%

42%

Consumer discretionary

51%

22%

27%

Financials

52%

11%

37%

Utilities

73%

2%

25%

Source: MSCI, 2016

What's more, there are sectors in the UK which are very global in their nature and derive very little of their profits from the UK or Europe, such as materials, healthcare, energy and IT.


ARM Holdings: the weapons supplier in the smartphone war

A great example to demonstrate this is to look at ARM Holdings (ARM). ARM is not a name you come across everyday, but you’re more than likely to come across its products every day. Their primary business is designing processes that go into most portable devices. They're in smartphones produced by Apple, Samsung, HTC, Nokia, Sony, as well as tablets like the Apple iPad. Their end product extends to smart watches, smart TVs, digital cameras and even the Sony PlayStation Portable. Their products impact just about everybody in the world.

For ARM, it's not a case of figuring out who’s going to win the smartphone war, Samsung or Apple. They're essentially the weapons supplier to all the participants in the war.

The main driver of growth for ARM has been the global smartphone market. They derive a lot of their revenue from the US, China, Taiwan, and South Korea. It's a global business exposed to global thematics. This means it's less likely to be impacted by underlying UK economic drivers.

What's more, 40% of its cost base is in the UK. Headquartered in Cambridge, they have significant research and development costs based in the UK and so are exposed to the British pound. On a direct basis, it's expected ARM will be a beneficiary of the British pound sell off, given its revenues are denominated globally, but a large component of its costs are denominated in British pounds.

The other trend ARM is benefiting from is the rise of digitalisation within cars, which most new car owners will have noticed. What's more, there are cars today that can drive themselves, and in time, cars will effectively become a supercomputer on wheels. ARM is already at the forefront of this trend, with its processes in these new super vehicles.

Of course there are some unknowns for ARM. They've probably benefitted from the mobility of labour into the UK, accessing both cheaper labour and intellectual property talent. So the impact, should the UK fully leave the EU, is not clear. But on balance, it appears it's not going to have a materially adverse impact on the business.

The question for ARM is not so much around the impact of Brexit, but more so, will people buy more smartphones? Will the path to the digitalisation of cars continue? Will the car become a supercomputer? The answer to all of these questions is most likely yes. These types of global, long-term thematics are what investors need to consider when assessing companies in the UK market. These are the opportunities that active managers think about when investing.

And interestingly, on 15 July 2016, it was announced ARM is being taken over at a 43% premium by Japan's Softbank. This further demonstrates how active managers can add value, by picking companies that are highly valued by the market.


Want to know if you're already an investor in ARM?

MLC is currently overweight ARM in the MLC Global Share Fund and Hedged Global Share Fund and it's a top 10 holding in MLC's global share strategies, so you'll find it in the MLC Horizon portfolios and some of the Inflation Plus portfolios. Find out more with MLC's fund profile tool and contact MLC or your financial adviser if you'd like to know more about investing globally.

 

Important information

This information is provided by MLC Investments Limited (ABN 30 002 641 661, AFSL 230705) ("MLC" or "We"), the Responsible Entity for the MLC Investment Trust and a member of the National Australia Bank Limited (ABN 12 004 044 937, AFSL 230686) group of companies ("NAB Group"), 105–153 Miller Street, North Sydney 2060.

This information may constitute general advice. It has been prepared without taking account of an investor's objectives, financial situation or needs and because of that an investor should, before acting on the advice, consider the appropriateness of the advice having regard to their personal objectives, financial situation and needs.

You should obtain a Product Disclosure Statement (PDS) relating to the financial products mentioned in this communication issued by MLC Investments Limited, and consider it before making any decision about whether to acquire or continue to hold these products. A copy of the PDSs for products mentioned in this communication are available upon request by phoning the MLC call centre on 132 652 or on our website at mlc.com.au

NAB does not guarantee or otherwise accept any liability in respect of any financial product referred to in this communication.

This information is directed to and prepared for Australian residents only.

Any opinions or analysis expressed in this article should not be considered a recommendation to purchase or sell any security. It should not be assumed that any investment in this security was, or will be, profitable or that the securities are held in the financial products mentioned.

Any opinions expressed in this communication constitute our judgement at the time of issue and are subject to change. We believe that the information contained in this communication is correct and that any estimates, opinions, conclusions or recommendations are reasonably held or made as at the time of compilation. However, no warranty is made as to their accuracy or reliability (which may change without notice) or other information contained in this communication.

The funds referred to herein are not sponsored, endorsed, or promoted by MSCI, and MSCI bears no liability with respect to any such fund.