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UK equities: Thinking outside the Brexit box

UK equities: Thinking outside the Brexit box

UK small-cap managers are finding plenty of attractive opportunities, despite widespread concerns over Brexit negotiations.

James Zimmerman, manager of the Jupiter UK Smaller Companies fund, prefers owner-managed businesses because there is greater choice. ‘The long-term outcomes for companies in which management and board have serious ownership are superior to those run by individuals, who are more likely to come and go,’ he explained.

Zimmerman believes technology companies have come to dominate global business and is surprised by the level of disruption that can be caused. ‘Understanding the long-term impact of a variety of technologies is an ever-growing component of my research,’ he said.

He favours companies with balance sheets that provide a good platform for growth and the potential to sustain investment during prolonged economic downturns. He does not take macro-economic bets or leave the portfolio overly exposed to specific macro risks. ‘The fund is well balanced between companies that are global in nature, those predominantly selling into the US market and firms with strong positions in the UK,’ he said.

Atypical opportunities

Georgina Brittain, Citywire A-rated manager of the JP Morgan Smaller Companies investment trust, has been finding opportunities in property and household-related sectors. ‘We own M J Gleeson, a very fast-growing housebuilder focused on low-cost housing,’ she said.

Another key holding in the portfolio is Victoria, a carpet manufacturer Brittain likes for its acquisitive nature. ‘It doesn’t sound glamorous or sexy, but this has been a stellar performer,’ she said.

Watkin Jones, the construction company she bought last year as an initial public offering, is also a favoured holding. ‘It’s building student housing at the moment so isn’t a typical construction company,’ she said. ‘It has a very different business model and higher margins.’

Brittain pointed out its developments are forward sold, which means it is not taking risks on the actual build costs. Moreover, student accommodation is a huge growth story in the UK.

Careful consideration

Despite her favoured names hailing from similar sectors, Brittain insists her approach is bottom-up and everything with healthy balance sheets will be considered. ‘We consider momentum, in both price and earnings, and look at value and quality,’ she said.

She particularly likes companies that are beating expectations, as this helps drive share prices. But she warns against being gung-ho, as many stocks in the small-cap space are expensive.

‘Our two key metrics are the humble PE [price-to-earnings ratio] and free cashflow,’ she said. ‘We like companies with healthy balance sheets that produce excess cash.’

Shopping for success

Although Brittain insists the overriding issue facing the sector is the potential fallout from Brexit, she remains optimistic about the future. ‘Our general view is the right companies in the UK can carry on delivering regardless of the Brexit outcome,’ she said.

Recently released figures back up the broadly optimistic stance of fund managers in the UK small-cap space towards domestic companies. Retail sales volumes grew at the fastest pace for two years in the year to September. This followed a decline in the previous month’s figures, according to the latest Confederation of British Industry (CBI) distributive trades survey.

In the retail sector, the main drivers of growth in overall volumes were the grocery and clothing sectors. ‘Retailers of furniture and carpets, specialist food and drink stores, and sellers of recreational goods reported falling sales volumes over the year to September,’ stated the report.

Anna Leach, CBI head of economic intelligence, believes it is encouraging to see vigour returning to the retail sector. But she warns the coming months could be difficult. ‘Inflation continues to squeeze household budgets and, with the pressure on incomes set to persist, retailers will continue to face a challenging environment,’ she said.

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