As portfolio managers of an international equity strategy, our primary focus is on our core competency: performing bottom-up analysis to identify stocks with the potential to provide a combination of high quality, strong growth, capital return to shareholders, and attractive valuations.
During episodes of volatility such as the immediate aftermath of the U.K.'s June 2016 Brexit vote to leave the European Union (EU), we seek to maintain a disciplined approach to stock selection. While we focus the majority of our efforts on bottom-up fundamental analysis, we do incorporate macroeconomic factors into our investment process. Given the difficulty of predicting outcomes such as the Brexit vote, this top-down analysis constitutes only a small piece of our overall investment process.
Following the Brexit vote, we decreased our strategy's weight in U.K.-domiciled equities, but not across the board. The U.K.-listed stocks that remained in the portfolio were high-quality, multinational companies domiciled in the United Kingdom and operating worldwide with a global customer base. While we expect the Brexit to weigh on the U.K. economy as industrial and consumer spending slows, we believe the impact on U.K.-based multinationals will be much less pronounced than on companies that are primarily exposed to the domestic economy. The wide geographic reach of several U.K.-based multinationals offered a measure of downside protection amid the broad market sell-off the day after the Brexit vote. For this reason, we monitor the portfolio's geographic exposure to regions and countries by revenue source in addition to understanding where companies are domiciled.
As for additional Brexit-related opportunities, we remain on the lookout for certain countries and companies that could benefit from the expanded monetary policies that central banks may implement to counter the negative impact of the Brexit vote. However, we are cautious in this regard, as we believe political uncertainty accompanied by a recent decline in business confidence in the EU may weigh on the effectiveness of the economic stimulus that these policies are intended to provide.
Sources of risk
While the global reach of U.K.-based multinationals could provide a source of revenue stability as the United Kingdom negotiates an exit from the EU, the Brexit is likely to add to the pressures on European banks, which have recently been tested amid the Continent's slow growth, low-yield environment and monetary policymakers' implementation of negative interest rates. Any momentum that the Brexit vote provides to emerging nationalist movements in other European countries could add to political instability, weighing on economic prospects and on banks.
As for the global economy, the most substantial impact of the U.K.'s eventual exit from the EU will likely be confined to domestic-focused, consumer-oriented U.K. companies and industries. We expectthat the U.K.'s GDP will decline modestly in 2017 as a result of the Brexit-enough to have a substantial impact on the EU generally, but not on the global economy.
Regardless of the disruptive potential of the Brexit vote, we will continue to seek opportunities in stocks—whether in the United Kingdom or elsewhere—that offer the unusual combination of high quality, strong growth, and capital returns to shareholders. In today's market, such stocks can be purchased at reasonable valuations, in our view, provided you know where—and how—to look.