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Post-Brexit Britain

10 March 2020

Where are UK Smaller Companies managers finding opportunities?

The UK Smaller Companies sector has been one of the most rewarding for investors over the past decade. The average return from an investment company in the sector over the past ten years is 303% (to end of February 2020), compared to 166% for the average investment company over the same period*.

Despite this strong long-term performance, worries remain about the UK’s relationship with its largest trading partner, the EU, not to mention the recent market falls. What does the future hold for smaller companies in post-Brexit Britain and where are managers finding opportunities?

At a media roundtable held today by the Association of Investment Companies (AIC), Dan Whitestone, Manager of BlackRock Throgmorton Trust, Jonathan Brown, Co-Manager of Invesco Perpetual UK Smaller Companies Investment Trust, and Stuart Widdowson, Co-Manager of Odyssean Investment Trust, discussed their recent investment activity, the effect of the coronavirus on their portfolios and their overall outlook for the sector in post-Brexit Britain. Their thoughts have been put together alongside comments from Charles Montanaro, Manager of Montanaro UK Smaller Companies.

Annabel Brodie-Smith, Communications Director of the Association of Investment Companies (AIC), said: “Investors willing to back smaller businesses on home soil have done well over the past decade. An investment in the average investment company in the UK Smaller Companies sector ten years ago would have quadrupled in value. The recent market sell-off is uncomfortable for investors. No-one knows what markets will do next but in the past investors who have kept their faith and remained invested have been well rewarded over the long term.

“This encouraging long-term performance shows that even though investing in smaller companies may carry more risk, it can really pay off over the long term. These rewards are amplified by the closed-ended structure. Given that many smaller companies’ shares can be illiquid, it’s a great advantage not to have to sell them into market downturns. Instead, closed-ended fund managers can invest right down to the smallest and least liquid companies in the knowledge that they will not have to sell these holdings before they are ready to do so.”

Have you seen any change in sentiment towards investing in smaller companies post-Woodford?

Charles Montanaro, Manager of Montanaro UK Smaller Companies, said: “The gating of a high-profile fund has brought to attention two things. The first is the dangers of owning illiquid and unquoted assets in an open-ended fund. Certainly this has highlighted the benefits of closed-ended structures which do not have to manage daily investment flows. The second is the risk of fund managers moving away from their area of expertise.  We have managed small and mid-cap portfolios for almost 30 years. It is all we have done and all we will ever do.

“Some of our clients wanted reassurance about the underlying liquidity of our funds, which was easy to provide. Debacles such as Woodford are actually positive for boutiques such as Montanaro that take a disciplined and pro-active approach to managing liquidity risk. It is an intrinsic part of what we do. 

“Generally, sentiment has not changed much for us. Woodford was not a specialist in small cap and did not have the in-house resources to conduct the required due diligence. The consequences were self-evident and predictable. It shows the importance of working with specialists in smaller companies who have the expertise and know what they are doing.”  

Where are you finding opportunities and what risks are you most focused on?

Stuart Widdowson, Co-Manager of Odyssean Investment Trust, said: “Opportunities now are similar to when we launched Odyssean Investment Trust in May 2018 – higher-growth, high-momentum stocks have become, in some cases, very over-valued. The value in the market is more with companies which are not quite firing on all cylinders.”

Jonathan Brown, Co-Manager of Invesco Perpetual UK Smaller Companies Investment Trust, said: “We are adding on a stock-specific basis rather than by sector. Where we can find good quality businesses with growth potential, at sensible valuations, that is always of interest to us. We have recently added to cyber security business NCC, UK estate agent LSL Property and Midwich, which is an audio-visual equipment distributor.

“We see risk around valuation in some of the popular momentum growth stocks and have been taking profit in some of those names and reinvesting it in more modestly valued businesses.”

Dan Whitestone, Manager of BlackRock Throgmorton Trust, said: “The main attraction of the universe of small and medium sized companies is the abundance of opportunities and the excitement of trying to uncover the next leader of the future. This might centre around a company with a differentiated product or business model that requires little capital to grow and has a small market share in a large and growing fragmented space - 4imprint, YouGov and Integrafin are all good examples.

“However, we also focus on long-term secular growth trends that individual companies are either driving or benefitting from. One such theme is ‘digital transformation’. In our view, this is a multi-year growth trend reflecting the strategic imperative for corporates to invest in their digital capabilities to either drive efficiency or yield improvements. This is a vast but growing industry which shows little signs of slowing.”

What is your outlook for the sector?

Jonathan Brown, Co-Manager of Invesco Perpetual UK Smaller Companies Investment Trust, said: “The beauty of small cap is the sheer diversity of opportunity available to investors. We are particularly interested in businesses with self-help characteristics, roll-out potential, sector consolidation plays and companies exposed to higher-growth niches in the economy. We believe these stocks can do well irrespective of the wider economy.”

Charles Montanaro, Manager of Montanaro UK Smaller Companies, said: “Predicting macro developments, such as the future direction of UK trade negotiations, sit outside our sphere of competence and are virtually impossible to predict. Rather, we spend our time meeting and listening to our companies. In our experience, this is where we can begin to understand the true drivers of growth that are so important to the trajectory of long-term investment returns. Whatever the political weather, the UK is home to some truly innovative, world-class businesses. We do not expect this to change and are optimistic about the future of the UK.”

Dan Whitestone, Manager of BlackRock Throgmorton Trust, said: “In our view, the Conservative majority in Parliament with a clear mandate to ‘get Brexit done’ removes tail risk. More clarity should lead to increased business confidence and corporate spending. This has the potential to create a healthy backdrop of improving corporate profitability both for domestic and global facing UK PLCs.

“There is an abundance of interesting growth companies to identify and no industry stands still. We remain alert and vigilant in detecting positive or negative change to our existing investments and also new opportunities. However, we still don’t know what Brexit will look like and there are many hurdles to overcome: trade negotiations may cause further volatility, not only as the UK seeks to renegotiate relationships but also between the US and China. Meanwhile, the recent coronavirus outbreak merits some caution. As a result, we have not made any significant changes to the portfolio at this stage.”

Stuart Widdowson, Co-Manager of Odyssean Investment Trust, said: “It’s difficult to generalise and it depends on what Brexit we end up with. There will always be winners and losers, and companies for which Brexit makes no difference. As an asset class, UK equities probably become more attractive once there is certainty on the nature of Brexit – and smaller companies will do well in that environment. A rational response would be a pick up in the IPO market, which would be welcomed as there has been a steady decline in the number of UK quoted smaller companies since 2000.”

-Ends-

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Notes

  1. The Association of Investment Companies (AIC) was founded in 1932 to represent the interests of the investment trust industry – the oldest form of collective investment.  Today, the AIC represents a broad range of closed-ended investment companies, incorporating investment trusts and other closed-ended investment companies and VCTs. The AIC’s members believe that the industry is best served if it is united and speaks with one voice. The AIC’s mission statement is to help members add value for shareholders over the longer term. The AIC has 363 members and the industry has total assets of approximately £201 billion.
  2. Disclaimer: The information contained in this press release does not constitute investment advice or personal recommendation and it is not an invitation or inducement to engage in investment activity. You should seek independent financial and, if appropriate, legal advice as to the suitability of any investment decision. Past performance is not a guide to future performance.  The value of investment company shares, and the income from them, can fall as well as rise.  You may not get back the full amount invested and, in some cases, nothing at all.
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Annabel Brodie-Smith
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