UK equity stocks were trading at a 30% discount to their global peers pre-crisis. Could this make the UK the place to invest for the recovery? And might small-mid cap benefit most? Darius McDermott, managing director, FundCalibre, takes a view.
Unstable politics and Brexit played a key role in what was a difficult decade for those investing in the UK in the 2010s.
However, the last few weeks of 2019 gave us cause for optimism amid hopes that Prime Minister Boris Johnson’s success in the General Election finally give us a strong, one party majority, that could deliver some clarity on Brexit.
How that all seems a long time ago! Covid-19 has hit the UK harder than most: since the start of 2020 the FTSE All Share – which represents 98% of the UK stock market – is down some 16.5% year to date, while the MSCI World is up 1.3%*.
Not only has the ongoing uncertainty of Brexit continued to hang over the economy, but I also wonder if we are being punished for being slack in following some of our counterparts in closing the country down – in terms of events and introducing social distancing – in a bid to tackle the coronavirus.
The UK economy has also re-opened much more slowly than other parts of Europe, which is also set to hit growth hard. UK GDP has shrunk by 25.1% since its peak in January 2020**, the steepest in modern times. Historic data from the Bank of England suggests it could be the deepest recession in almost three centuries.
With 600,000 job losses between March and May (and many more on the horizon) and growth set to fall by 10.2%*** this year, the picture does look somewhat bleak. However, these figures are also being seen in other parts of the developed world, which makes me wonder whether the UK is the most likely growth market for success in the medium to long-term. Let’s not forget that the rhetoric at the end of 2019 was that UK equities were at a 30% discount to global peers – close to a 30-year low, as domestically-focused stocks remained out of favour^.
Mid and small-caps for growth
It may well be those domestically-focused stocks that sit in the small and mid-cap space that offer the best value going forwards. I say this because the FTSE 100 primarily consists of pharmaceuticals, financials, oil and mining companies, meaning a big chunk of the index is value driven. Historically, low rates and some £2 trillion of quantitative easing (QE) in the past decade have been a disaster for value investing. The past three months have seen rates go even lower and we’ve seen as much QE in that time as we saw in the aftermath of the financial crisis. Growth has dominated in the past decade and I see no immediate reason why that should change in the next.
We know small and mid-caps have suffered more than most due to Covid – but our weak currency has also held them back. However, if you believe in mean reversion, the currency should appreciate against the Euro and the Dollar at some stage. And, importantly, small and mid-cap funds have the freedom to be much more active in terms of the sectors they operate in – that nimbleness will be essential as markets recover.
The other attraction is the valuations, as many of the concerns are already priced in, which means there will be lots of opportunities to access companies at attractive prices. The key will be the shape of the recovery in the next 6-12 months and the one intangible that markets have not priced in, which is the impact of a second lockdown. With this in mind I believe the best prospects come from companies which provide a true multi-cap approach, giving them additional flexibility in the future.
A good option to consider would be the Liontrust Special Situations fund; which is multi-cap in nature, but typically has an overweight to mid and small-cap stocks. Managers Anthony Cross and Julian Fosh only include stocks in the portfolio which have either intellectual property, a strong distribution network or recurring revenues. The fund is a firm favourite and a stellar performer in the long-term.
Another would be the Man GLG Income fund, managed by Henry Dixon. This a very flexible multi-cap vehicle, which not only invests in UK companies of all-sizes but can also invest in continental European companies that derive a substantial part of their revenues from the UK. It also has the ability to selectively invest in corporate bonds.
Those who do want to specifically target the mid and small-cap space may prefer a growth orientated vehicle like AXA Framlington UK Mid Cap or TB Amati UK Smaller Companies.
Past performance is not a reliable guide to future returns. You may not get back the amount originally invested, and tax rules can change over time. Darius’s views are his own and do not constitute financial advice.
*Source: FE Analytics, total returns in sterling, FTSE All Share and MSCI World from 1 January 2020 to 3 July 2020
**Source: Schroders: Slow exit from lockdown hits UK growth
***Source: IMF World Economic Outlook – June 2020
^Source: Cazenove Capital: Outlook 2020: UK equities
