“Cautiously optimistic” was the phrase I used to describe the outlook for the UK market at the end of 2019, after the outcome of the general election finally gave us political stability for the first time in almost four years.
Less than four months later and there is talk of a 35% fall in UK GDP in the second quarter of 2020, with up to two million people set to lose their jobs as the economy continues to suffer in this lockdown scenario*.
I’ve never seen the economy move as quickly as this in my lifetime. The idea of a V-shaped recovery seems to have died a death in less than a month, with Us and Ls being touted, depending on how optimistic you are. At this time, I’d take any recovery scenario.
The implications of lockdown are now putting pressure on the balance sheets of all UK business, but UK smaller companies are in the eye of the storm. Since 20 February, funds in the Investment Association UK Smaller Companies sector have fallen by 26.5%**. At one stage in March they were down almost 40%**.
Despite attempts by the UK government to offer financial support to businesses during the pandemic – including the Coronavirus Business Interruption Loan Scheme (CBILS), which grants emergency funding to businesses – the speed of the downturn and the impact on revenues has hit these businesses hard.
However, history suggests you ignore smaller companies at your peril if you are looking for long-term growth. The Numis smaller companies index has returned more than twice as much as the FTSE All Share in the past decade alone (94% compared with 48%)^.
What the fund managers are saying
Most of the calls I’ve had in the past few weeks with small-cap managers have focused around three main areas, namely how exposed they are to cyclical stocks, the balance sheets of the companies they hold and communication.
Liontrust UK Smaller Companies fund manager Anthony Cross says they have limited exposure to classic UK consumer cyclicality and ‘person-to-person’ contact such as the travel, transport, pubs/restaurants, retailing, leisure and aviation sectors, instead holding around 60% in industrials, technology and financial companies.^^
Anthony says the fund also contains companies with solid balance sheets, with over two-thirds of them having a net cash position while a similar proportion paid a consistent dividend. He acknowledges that markets are challenging, and situations can change quickly, so they have written to the brokers of their companies calling on them to act quickly if they need equity funding.^^
LF Gresham House UK Micro Cap fund manager Ken Wotton says his team has lowered exposure to cyclical companies in the portfolio to limit downside risk and maintain liquidity. However, he has also taken advantage by investing in businesses he feels now have compelling valuations, such as Inspired Energy and Dominos Pizza. He believes the market environment will provide “unprecedented opportunities to back fantastic businesses at attractive prices either due to forced sellers in the market or through capital raises”.^^^
TB Amati UK Smaller Companies fund manager Paul Jourdan also believes there could be opportunities to take advantage of. The team held a 9% cash position in March, some of which was for potential share placings.
The fund also holds a bucket of defensive names, as well as companies the team feels the market has treated harshly by overestimating the impact on their businesses. Examples of this include Intermediate Capital, Grainger and Sumo Group – all of which sit in the top 10 holdings.^^^^
Clearly now is a time to be ultra-cautious given the uncertainty – but that uncertainty also brings opportunity. We are bound to see consolidation across all of the market, but we will get some winners from this difficult period with well-capitalised businesses set to come out stronger – particularly in the UK smaller companies’ market. I would not dissuade those looking to take advantage of this uncertainty.
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: Office for Budget Responsibility, 14 April 2020
**Source: FE Analytics, IA UK Smaller Companies sector average, total returns sterling, 20 February 2020 to 15 April 2020
^ Source: FE Analytics, total returns in sterling for Numis Smaller Companies 1000 Excluding Investment Companies and the FTSE All Share, 15 April 2010 to 15 April 2020.
^^Source: Liontrust UK Smaller Companies – March 2020 review
^^^Source: Gresham House: Finding opportunities in a rapidly changing world – March 2020
^^^^Source: Fund factsheet, March 2020
