The word Brexit still has the power to spark violent disagreement, not least when it comes to the consequences for the economy and the financial markets.
Whether you think opportunities to make money from Brexit exist may well be correlated to how you voted in 2016, but Telegraph Money believes there is at least one uncontroversial, if little appreciated, way in which Brexit allows us to make better gains than would be available had we voted to remain.
What we have in mind is not a get-rich-quick idea – quite the opposite in fact. But it should, over the course of the following years, or ideally decades, produce reliable returns; returns that will be greater than they would have been if we were still in the EU.
Buy low, sell high
Let’s start with the most basic investment rule of all: buy low and sell high. Even now, seven years after the Brexit vote, the London stock market is lower as a result of our departure from the European Union.
While we cannot prove this, professional observers are almost unanimous that international investors have been shunning British assets ever since the vote, which inevitably means that share prices are lower than they would otherwise have been.
To state the obvious again, low share prices are bad if you’re about to sell but great if you’re about to buy. So for first-time investors who are looking for a good place to put savings for the long term, British shares offer an advantage.
Ah, you may say, but what if those British shares remain cheaper than their overseas counterparts? Surely then their current cheapness will be of no benefit – I may buy cheaply but I’ll end up selling cheaply too?
This is true as far as it goes. However, there are two reasons to think it will not derail our idea.
The first is simply that this column does not expect the London stock market’s relative cheapness to last, even if it’s impossible to say when overseas investors might decide to return in force to these shores. Almost all investment decisions are based partly on reason and partly on sentiment, and it was the latter that was dealt an enormous blow by the Brexit vote.
In time, we can expect that negative sentiment to fade, particularly if investors’ rational side starts to recognise that this country remains home to many solid, successful businesses.
The second reason is more subtle, but it offers a way to profit from Brexit that should work in investors’ favour even if sentiment towards Britain remains as downbeat as it is now and if consequently London-listed shares never regain their previous valuations relative to their profits.
Opt for undervalued shares which pay an income
Let’s return to that question of buying low. As we said, doing so is of no benefit if we have to sell low too. Or at least it risks being of no benefit if we receive no income in the meantime. But things change if the company concerned pays a dividend.
Let’s look at two imaginary businesses, Alpha plc and Beta plc. Each has a share price of 80p but we assume that each would have a share price of 100p had Brexit never happened. We also assume that the share price remains static for five years in either case.
Alpha pays no dividend and, although we paid less for it (80p) than we would have without Brexit (100p), when we sell it at 80p in five years’ time we are no better off.
Beta however pays a dividend of 5p a share, which we assume is the same every year. We also assume, importantly, that it would still have been 5p had Britain remained in the EU (a reasonable assumption if UK share prices now are in fact lower simply because of the deterioration in sentiment).
Now we assume in all cases that we invested £100 in the shares of these companies. With Alpha, we invest £100 and we get back £100 because the share price doesn’t change and we have received no dividends. Our total return is nil. With Beta, when we invest at 80p a share our £100 gets us 125 shares.
Thanks to the dividend, each year we hold the shares we get £6.25. Over the course of five years our total income is £31.25. We sell at 80p after five years so our total return is the dividend income of £31.25 or 31.3pc of our investment.
Had Brexit not depressed the share price and we’d paid 100p for our shares in Beta, we would have got only 100 shares for our money. These 100 shares would have produced annual dividend income of £5, or a total of £25 over our five-year holding period, for a total return of 25pc.
We can see that, even if share prices never improve, the initial depression in price caused by Brexit has led to a greater return.
But there is more. Imagine if we had reinvested those Beta dividends every year. By Questor’s calculations reinvesting five years of share payouts in Beta’s shares when the purchase price was 100p (no Brexit) would give a total return of 27.6pc while doing so at a purchase price of 80p (Brexit) produces a total return of 35.4pc.
We have looked at the case where a company pays some of its profits to shareholders in dividends for the sake of simplicity.
But the argument that a depressed purchase price can lead to better returns even if the valuations of British shares remain depressed holds water even if companies do not pay a dividend, provided that they themselves reinvest their profits productively.
Doing so would by definition mean that their profits improved, so that, even if the market continued to value the shares at the same low multiple of those profits, the share price would rise. But again we would make a bigger gain by buying at a lower share price because the amount the company made in profits relative to our initial investment would be higher.
Choose smaller companies for the biggest gains
There are yet further ways in which we can turn Brexit to our advantage. While commentators agree that our decision to leave the EU depressed the share prices of British stocks, the effect was greater on smaller companies, many of which are likely to be unfamiliar to overseas investors.
Provided that you invest in smaller stocks that pay a reliable dividend, or are able to reinvest their profits effectively, their depressed share prices should enable you to make even bigger gains. Again, this is true even if there is no improvement in sentiment towards British stocks.
But you can get even more bang for your buck if you invest in cheap British shares via cheap investment trusts, which are funds quoted on the stock market. Independently of the cheapness of the companies that investment trusts own in their portfolios, the trusts themselves can be cheap in the sense that they can trade on the stock market at a discount to the value of their assets.
Let’s look at an imaginary investment trust called Gamma plc. It owns 30 British stocks and its holdings of those stocks have a combined value, as determined by their share prices, of £100m. But because shares in Gamma are also traded on the stock market and can also rise and fall in response to fluctuations in demand, the trust itself might have a stock market value of just £80m, which would mean it was trading at a discount of 20pc to the value of its assets.
A comprehensive guide on how to invest – and where to put your money
Now, just as the share price of a company can be depressed and stay depressed, so too can the discount on an investment trust.
But the arguments outlined above regarding the effect of a low purchase price on the value of subsequent dividend income (or income reinvested by the company concerned) apply equally to investment trusts. In other words, if Brexit caused a trust to trade at a 10pc discount when previously there was no discount, you will make a better return if you hold it for five, 10 or 20 years, even if the discount remains the same, as long as the trust pays an income or its holdings reinvest their profits effectively.
So Telegraph Money’s advice is this if you want to profit from Brexit: buy British, ideally British smaller companies, and buy them via an investment trust that pays a good income and is trading at a discount.
One example is the Diverse Income Trust, which has a dividend yield of 5pc and trades at a discount of 7.7pc. The trust, managed by the respected investors Gervais Williams and Martin Turner, invests in companies of all sizes but has a focus on smaller firms. Another is Montanaro UK Smaller Companies, which yields 4.6pc and trades at a discount of 10.6pc.
Alternatives include the Invesco Perpetual UK, Aberforth, Henderson, BlackRock and JP Morgan UK Smaller Companies trusts. You can find more details of each trust on the website of the Association of Investment Companies, the investment trust trade body – look under sectors “UK Equity Income” and “UK Smaller Companies”).