Morningstar - Summer 2019 - 72

Strategies

EXHIBIT 5

Brexit Effect A revenue-weighted version of the Morningstar UK Large-Mid Index has substantially underperformed the
cap-weighted version of the index since the Brexit vote in June 2016. That month, there was a 9.5-percentage-point difference
between the two indexes.
Performance of Revenue-Weighted Version of Morningstar UK Large-Mid Index Versus Cap-Weighted Version (Monthly, GBP)

Cumulative Return
5%

2.91
0

-5

-9.49
07/2014

07/2015

07/2016

-10
07/2017

10/2018

Source: Morningstar Direct. Data as of 10/31/2018.

U.K., respectively. Investors who are concerned
about a Brexit recession might consider Troy Trojan
Income, which at 32.9% has the smallest
revenue exposure to its home country. JOHCM UK
Equity Income has a 43.5% exposure.

Companies' geographic sources of revenue
also matter in the aftermath of surprising political
events. That is what a comparison between
a revenue-weighted benchmark and its marketcap-weighted counterpart suggests after
the U.K.'s June 2016 vote to leave the European
Union. We constructed the revenue-weighted
benchmark using the Morningstar UK LargeMid Index. We eliminated constituents without
any domestic revenue and then weighted
each stock by multiplying its market-cap float with
its domestic revenue percentage. The resulting
revenue-weighted benchmark had a substantially
higher weighting in the financials sector
and lower weighting in materials relative to its
market-cap-weighted counterpart.
The U.K. revenue-weighted benchmark behaved as
one might have expected in response to a major
domestic shock. Fear concerning the negative
economic consequences of the Brexit decision has
been a major impetus in the subsequent

Morningstar Summer 2019

underperformance of the revenue-weighted
version of the U.K. index. From the day after the
Brexit vote through October 2018 (when
our data ends), the revenue-weighted benchmark's
2.8% cumulative gain in GBP trailed the
market-weighted index by a whopping 20.2
percentage points.
Lest there be any doubt that the U.K.'s
surprise decision figured into this performance gap,
E X H I BI T 5 depicts the month-by-month
performance differential between the two U.K.
indexes. The month of the Brexit vote stands
out. In June 2016, the revenue-weighted index lost
9.5 percentage points more in GBP than its
market-cap-weighted counterpart. That's a huge
difference between two indexes that-despite
their different weighting methodologies-
share a 0.9 correlation, 98% similarity of holdings,
and less than 50% active share.
A Lens to Geographical Risks
The Revenue Exposure by Region lens gives
investors an important tool for gauging
geographic exposures within their portfolios that
may not be readily apparent from looking at
domicile alone. A company's country of
domicile will continue to be important, but

domicile-based measures cannot capture the
geographic diversity inherent in most companies'
revenue streams, much less a portfolio of
those companies. And in certain cases, domicilebased measures prove misleading.
Revenue Exposure by Region gives investors the
ability to determine the global makeup of their
equity portfolios. Those seeking revenue diversity
in their portfolios can tilt toward strategies
with diverse revenue mixes or add options to
redress underexposure. Investors can also choose
to tilt toward or away from a region or country
for macroeconomic reasons, such as a debilitating
trade war or Brexit-like scenario. In the end,
use of this tool allows investors to be more aware
of the geographical risks they are taking. K
Tom Whitelaw is director, equity ratings, with Morningstar
Research Services.
Alec Lucas is a senior analyst, equity strategies, with
Morningstar Research Services.
Robby Greengold is a senior analyst, equity strategies,
with Morningstar Research Services.
Dimitar Boyadzhiev, an analyst, manager research, with
Morningstar UK, and Michael Malseed, a senior analyst,
manager research, with Morningstar Australasia,
contributed to this report.

Morningstar - Summer 2019

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