Holding onto small and mid-caps has proved painful for UK investors recently, with data from FE fundinfo showing the FTSE 250 is up just 1.6% year to date, while the Deutsche Numis Smaller Companies excluding investment companies index has fallen by 1.7%
By contrast, the wider FTSE All-Share is up 4.9%, driven by the FTSE 100 surging 5.3% so far this year.
Jupiter’s Adrian Gosden said: “If you’ve come outside the FTSE 100 and braved the waters of SMID caps, it’s been a horror show.
“House building shares are down 45% in 12 months, companies that make the bricks for that market are down 50%, and if you’ve come across a hospitality company that’s still trading, it’s lost half its profitability in the past year.”
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For example, he pointed to businesses such as hotel branch Whitbread, which saw profitability tank on the back of rises to national insurance and minimum wage, an outcome that seemed to “surprise” the government.
Meanwhile, large caps have thrived owing to their international revenues, which have protected them from recent challenges, the Jupiter manager said. Gosden pointed to examples such as Rio Tinto or BP, which are up 84% and 50% over the past 12 months, respectively.
This underperformance from small and mid-caps versus their larger counterparts has been a trend in the UK market for almost a decade, as demonstrated by the data below.
However, the Jupiter team are undeterred by the recent “horror show” in small and mid-caps equities.
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“I genuinely believe the best opportunity right now is in small and mid-caps,” he said.
“That SMID cap area is trading at a 20-year discount to its larger brother,” he added. “I’ve seen that once in my career, and the returns on the other side were spectacular.”
Over the past 20 years, the Deutsche Numis Smaller Companies is up 309%, with the FTSE 250 trailing just behind at 301.8% return. The FTSE 100, meanwhile, was up 268.2%, as demonstrated by the table below.
The underperformance of UK businesses has been mostly a function of investor pessimism and trading, he explained, rather than any real lack of quality or fundamentals.
However, this presents an opportunity to buy strong stocks at very compelling prices, according to the manager.
“The narrative about investing in the UK is that it’s a complete waste of time,” he said. “I have some sympathy with that, but the facts just aren’t there.”
When stocks are trading at such low valuations, even a minor uptick in growth and profitability can be heavily multiplied, according to the Jupiter manager.
“A 1% improvement in the top line is a 20% improvement in the bottom,” said Gosden. “If a brick company on a discount sold 5% more bricks, the profitability doubles.”
This represents a great starting point for some currently struggling SMIDs, such as FTSE 250 stone and landscaping business Marshalls PLC, according to the Jupiter manager.
The stock has struggled over the past 12 months, with share prices cratering by about 55% (as of 13 May) and causing its valuation to drop to about 8x price-to-earnings (P/E).
“It’s not the valuation that’s your problem, it’s the trading,” Gosden said. “If that trading wasn’t quite so cretinous, you could double your money at minimum.”
With affordable housing still well below the government’s targets and infrastructure spending yet to come through, housebuilding businesses such as Marshalls and MJ Gleasons could benefit from greater governmental action, he explained.
“There’s a great opportunity there, but you need to feel your way into it,” he said. “Things are changing at such a velocity now, and you have to evolve with it”
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Within Gosden’s Jupiter UK Multi-Cap Income fund, SMID caps represent 64.8% of the total portfolio (48.2% in small caps and 16.6% in mid-caps).
