Amidst the volatile stock market conditions that followed the decision to leave the European Union, the justification for investing in UK smaller companies still stands, in my view. The protracted negotiations that will ensue in a post-Brexit world may have moved the dial slightly for investors but, until we get greater political clarity, it is difficult to see by how much. As for the concerted central bank action that is taking place at the time of writing, the paltry yield on offer for Gilt investors only strengthens the case for higher yielding equities, and many UK smaller companies displaying above-average growth characteristics.
Sterling has been impacted most by Brexit
While the dynamics in the bond market may change, currency markets have taken the bulk of the Brexit impact. The dramatic fall in the pound against the US dollar, is something we must not ignore. In that respect, we have dialled down some of our UK exposure in the portfolio and increased our exposure towards UK companies with overseas earnings. Furthermore, we’ve included some gold miners in the portfolio, such as the London-listed gold miners, Acacia Mining and Centamin, as a hedge against what, we believe, could be increasing amounts of volatility in equity markets.
The approximate split for the Numis Smaller Companies index between companies that with UK domestically-driven sales and UK companies with overseas earnings is around 70%:30%. Having been modestly overweight the UK domestically orientated part of our universe pre-referendum, we have tilted the portfolio more towards some of the available UK listed overseas earners, such that our domestic: international mix is now 65%:35%.
Dialling up the strategy’s overseas content
In order to effect this change, we have, post referendum, been buying internationally-orientated stocks such as Imagination Technologies, the UK-based designer of microchips for iPhones, drugs distributor, Clinigen, veterinary pharmaceuticals company, Eco Animal Health and software companies such as accesso and First Derivatives. By contrast, domestically-orientated names which have exited the portfolio include Pets At Home, Galliford Try and Morgan Sindall.
Nevertheless, our two overriding strategy themes remain; the quest for structural growth opportunities and the need to hold strong, cash-generative companies. The investment cases for companies with clear structural growth drivers such as Fevertree Drinks and Just Eat, are only partially played out, in our view, with both companies likely to produce above average growth for many years to come. In its latest interim results statement, for example, Fevertree increased first half sales organically by 70% and growth prospects continue to look exceptionally strong. As another structural play, Just Eat benefits from the huge growth in consumers adjusting to the convenience and ease of ordering takeaway food which technology brings.
A prime example of a highly cash generative company that produces a sustainable income stream is software manufacturer, Micro Focus. The company looks set to return around 20-25% of its current market capitalisation to shareholders over the next three years while delivering low but steady profits growth from mature, or maturing, products.
The decision to leave the European Union may well have created some uncertainty in terms of the outlook for the UK consumer and for investment, but we have continued to focus on constructing a portfolio that we believe will deliver much better earnings growth than our reference index – we estimate that our portfolio will deliver earnings growth of 14% in 2016 compared to around 2% for the Numis Smaller Companies Index. As smaller companies’ investors, we are fortunate in that the breadth of our investment universe continues to offer what we consider to be attractive stock-picking opportunities.