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Unloved UK and Europe small caps due ‘double catch-up’

2 July 2020

Veteran smaller company investors Gervais Williams and Francesco Conte explain why they can find resilient and nimble stocks in the coronavirus crisis.

Miton fund manager Gervais Williams has warned the UK’s recovery from the Covid-19 crisis will not be ‘robust’ but insisted the tough times ahead provide the opportunity for a ‘double catch-up trade’ for unloved smaller companies. 

UK ‘small-cap’ stocks were already trading at historically low valuations, dragged lower by the Brexit vote in 2016 and subsequent political uncertainty, before they had to face the disruption of the Covid-19 pandemic. 

Williams (pictured) said that prior to Brexit, investors ‘didn’t mind’ if they were invested in the UK or the US but ‘with political deadlock [after the EU referendum], a lot of asset allocators skewed away so the UK is now cheap compared to the US and many others’.

‘And small-caps are cheap versus large-caps so there is the opportunity for a double catch-up trade to be had,’ he said.  

Williams, a veteran small-cap investor, has reason to feel chipper after a defensive bet against the FTSE 100 paid off in the midst of the coronavirus lockdown. His £53.8m Miton UK Smaller Companies fund, which slumped to the bottom of its sector last year after losing 14%, is a top performer this year, up 19% year-to-date.

His £852m Miton UK Multi-Cap Income portfolio, which invests in smalle and large stocks, has weathered turbulent markets much better than its peers, falling 8% year-to-date versus a 21% fall in the average IA UK Equity Income sector fund.

Similarly, Williams’ £295m Diverse Income (DIVI ) investment trust has limited its decline to 11.4% this year, with the shares trading 7% below their underlying net asset value, which is a narrower discount than most rivals in the Association of Investment Companies’ UK All Companies sector.

However, speaking on an AIC media webinar this week, Williams was under no illusion that the road ahead would be difficult and said ‘generally, I think the prospects for the UK are unexciting’.

‘The government has bridged the corporate cashflow squeeze at present, but if there are ongoing virus hotspots, we worry that the government won’t be able to keep borrowing at an elevated rate for too long,’ he said.

‘So overall, we think the economic recovery won’t be robust.’

A faltering recovery will make it difficult for ‘mainstream  companies’ to grow but Williams believes more nimble smaller companies will ‘be able to take market share from those that have become insolvent’.

Williams said this scenario was unique in the UK stock market, which is the ‘world leader’ in listed smaller companies and means, overall, the UK stock market will ‘outperform most others’

Speaking at the same event, Francesco Conte (pictured), manager of the £536m JP Morgan European Smaller Companies (JESC ) trust, was equally optimistic about small-caps and medium-sized companies in continental Europe.

Conte also runs the £164m JPM Europe Smaller Companies fund, which has far outpaced its IA European Smaller Companies sector peers over the past year, returning 5.5% versus 1.7% from the average fund. 

He said being a European fund manager ‘is a really tough call’ as the region is ‘permanently out of favour’ and typically for ‘good reason’ but he argued the European small-cap index is’one of the best indices in the world’. 

‘A lot of the companies are world leaders...and in many sectors they are oligopolistic in structure, they focus on IP, and have the highest quality,’ he said. 

‘During Covid-19 smaller companies have had a big downgrade but much of that has come back already due to central bank [support] and the...government doing its utmost to prop up economies.’ 

One company that has proved particularly strong for Conte is Shop Apotheke (SAE.DE), the number two pharmacy chain in Germany.

‘We looked at these business and thought they were tomorrow’s stories but with coronavirus, customers, who tend to be elderly and most at risk, have opened up accounts...the number of customers has exploded.’

He said the boost isn’t ‘transient’ either as the German parliament has passed a law to make it mandatory for pharmacies to have online prescription services.

‘Shop ApotHeke’s penetration of the online pharmacy is 10% and if they apply their market share, there will be in excess of£1bn of sales,’ said Conte. 

Conte bought into ‘online pharma early on in the crisis’ and also topped up stakes in semiconductors ‘which will keep growing as the economy recovers’ but had been sold off in the downturn. 

While Conte has faith in European smaller companies he was aware that the region’s dominance in the manufacture of premium cars and luxury goods would be an obstacle as governments, consumers, and investors become more wary of globalisation. 

‘In a way, the end of globalisation is a theme that had already begun many years ago,’ he said, pointing to Germany policy to counter its fear of the deindustrialisation of the country. 

He said it marked a push into artificial intelligence in manufacturing that will eventually mean labour will be a less important part of manufacturing and companies ‘will no longer need to produce in the emerging markets’.

Williams, who penned a book on the theme, called The Retreat of Globalisation, said coronavirus may be another nail in the coffin for globalisation and push markets back to the 1980s, to a time when small-caps had more influence. 

He said during this time the ‘mainstream stock market did appreciate but not by much more than inflation’ and the ‘proper money’ was made in smaller companies.

‘I am expecting that pattern to reoccur,’ he said. 

Investment company news brought to you by Citywire Financial Publishers Limited.

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