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Brexit Tremors Prove Virtue of True Geographical Exposure

Brexit Tremors Prove Virtue of True Geographical Exposure

Jul. 14, 2016

Jul. 14, 2016

The market response to the result of the UK’s EU referendum on Jun. 23 – an 11% slump in both sterling and European equities in two days – was indicative of the momentous scale of such a decision. Investors scrambled to gauge the effect that a British exit will have on the region’s trade and growth, as well as the impact of a weaker pound and euro. Judging by the scope of the sell-off, investors expect dire economic consequences.

Polls and most analysts had failed to predict a `Leave’ victory. And yet, the result may be only the first chapter in a likely period of deep uncertainty for Britain, both politically and economically. When and how the country will end its EU membership, and what sort of relationship between the two parties will emerge, has yet to be defined.

The length of the departure negotiations will undoubtedly prompt companies to halt investment and hiring decisions, and consumers to slow spending, amid the uncertain outlook. 

UK revenue exposure

With the benefit of hindsight, investors who had hedged their exposure to the UK – the world’s fifth-largest economy – were able to relatively protect their holdings.

Not surprisingly, those companies most exposed to the UK bore the brunt of losses. An analysis by STOXX Ltd. shows the extent of that differential: After dividing all members of the UK market into four quartiles according to their revenue dependence on the domestic economy, the study shows that companies with the highest exposure to the UK (those for which between 75% and 100% of sales are derived from the country) fell, as a median performance, 10.3% on the day after the vote. By contrast, the quartile of companies that get a quarter or less of revenue from the UK rose 0.8%.

A similar trend was observed within US companies, even if the differential between the four quartiles was noticeably narrower. The group of companies with the highest sales to the UK dropped 5% on Jun. 24, compared with a 2.1% decline for those with zero-to-25% dependence on the UK. The real geographical exposure of businesses, as shown above, is a key source of value and risk and something that features high in investors’ minds.

The pattern extended into the following week, ending July 1, when companies with the highest ratios of British revenues in the UK and the US showed the worst performance. This happened even as market sentiment improved and indices across the board posted gains.

Mitigating geographic risks

Taking the same quartile classification of the analysis above, the STOXX True Exposure™ Indices offer a similar regional-revenue approach on conventional regional and country benchmarks. The STOXX TRU™ Indices, as they are known, allow investments into predefined countries or regions by selecting companies that have a dominant economic exposure to the targeted area rather than looking at where their headquarters are based. For more on the indices, please click here.   

Table 1 shows the performance on Jun. 24 of the STOXX UK 180 and STOXX USA 900 indices, labeled `benchmark’. To the right are the four categories of their derived STOXX TRU Indices (from 25% to 100% minimum exposure to the UK and US, respectively) and their performances. In the UK case, the higher the “required” revenue exposure to the local market, the worst the performance. For the US, on the other hand, the opposite holds true.



TRU 25%

TRU 50%

TRU 75%

TRU 100%














”With the STOXX TRU index solutions, investors had, in this instance, a tool at hand to mitigate the effect of a potential negative Brexit outcome on stock prices,’’ said Dr. Jan-Carl Plagge, Head of Applied Research at STOXX. ”This is precisely the idea behind the STOXX TRU Indices: understanding regional revenue exposures of single companies or entire portfolios to allow investors to be in control and to make active decisions about markets to which they want or do not want to be exposed to. Rather than to leave it subject to the composition of conventional indices."        

Brexit was an unusual phenomenon in that it is not often that such level of volatility is centered around one of the world’s most advanced economies. Market tail risks work that way: the more unexpected the event, the wider its repercussion. The UK vote is a reminder that being able to create a portfolio of real geographical exposure can protect it of Brexit-like events and is a useful option for investment allocations.



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