UK companies, particularly those exposed to the domestic economy, have become undervalued due to negative investor sentiment created by the uncertainty surrounding Brexit and the country’s future trade relations.
Value opportunity in high-growth area
Good long-term performance
Flexible strategy to match macro situation
Potential volatility
Some stocks have avoided this. More internationally focused and often larger companies have benefited from sterling depreciation, with their share prices rising alongside their currency-dependent revenues. The share prices of those that do not benefit and are UK-focused have risen timidly or not at all, below what their fundamental valuation and growth prospects suggest.
These companies could provide a value opportunity, particularly if the uncertainty surrounding the UK’s economic outlook diminishes and economic growth and consumer confidence returns. These also tend to be FTSE 250 stocks or smaller, so now could be a good entry point into UK mid-caps. According to Bloomberg, the FTSE 250 currently has a price/earnings (PE) ratio of 15.1, much below its long-term (since 1986) average of 19.8 – so there is space for valuations to rise.
Gavin Haynes, managing director at wealth manager Whitechurch Securities, says: “There is no doubt that UK stocks with a domestic focus have been indiscriminately shunned due to Brexit concerns. The uncertainty will provide a headwind, but also provides investors taking a longer-term approach with a chance of finding attractive stocks that have been oversold.”
One way to get exposure to these is Old Mutual UK Mid Cap Fund (GB00B1XG9482), run by Richard Watts. Mr Watts has a long and good track record in UK mid-cap investing, known for spotting nascent businesses that are well placed to grow. He bought this fund's largest holding, boohoo (BOO), in March 2014, since when the share price has risen over 200 per cent. The fund's third largest holding Fevertree Drinks (FEVR) has also risen 200 per cent since purchase in June 2016.
The fund has beaten its benchmark, the FTSE 250 ex-Investment Trust index, and been one of the top-performing funds in the Investment Association (IA) UK All Companies sector, over three and five years.
While Mr Watts has a keen eye for growth stocks, and analyses investments based on their own merits, using valuation metrics to ensure a good return, he also manages stock selection using macroeconomic analysis. This means the fund is designed to do well in different circumstances, and not only outperform in mid-cap bull markets but also when they struggle.
After the EU referendum, UK mid-caps were badly affected by negative sentiment towards the UK economy, with the FTSE 250 initially plummeting and only rising 15 per cent in the following 12 months. The fund returned 30 per cent during the same period.
Between 2013 and 2015, when UK equities generally provided lacklustre returns, mid-cap stocks performed well, and Mr Watts performed even better. He returned 87 per cent, versus 55 per cent for the FTSE 250 ex-IT and 23 per cent for the FTSE All-Share indices.
The fund also invests further down the market cap spectrum and will hold micro-caps, stocks on the Alternative Investment Market (Aim) shares and unlisted holdings. Mr Watts will also retain holdings that grow into the FTSE 100 if he expects more growth, such as Ashtead Group (AHT), a top 10 holding he first bought in 2010 and whose share price has subsequently risen over 1,400 per cent.
There are risks, however. Smaller companies are riskier and more volatile than large-caps, and require more patience. An allocation to these should never make up a significant part of your portfolio.
Mr Watts’ fund is heavily concentrated in the top 10 holdings which makes the fund more volatile than the benchmark as it is less diversified, so the ride may well be bumpy. It is also very large, currently £3.6bn in size, meaning it could at some point close to new investors to manage capacity. There is also the risk Brexit that derails the UK economy.
Nonetheless, negative sentiment towards UK-focused and mid-cap stocks has provided an excellent time to buy, and Mr Watts’ ability to judge which companies are above average is proven. Buy. TL
Old Mutual UK Mid Cap (GB00B1XG9482)
| PRICE | 329p* | MEAN RETURN | 9%* |
| IA SECTOR | IA UK All Companies | SHARPE RATIO | 1.15* |
| FUND TYPE | Open-ended investment company | STANDARD DEVIATION | 18.31* |
| FUND SIZE | £3.6bn | ONGOING CHARGE | 0.85% |
| No OF HOLDINGS | 47 | YIELD | 0.95% |
| SET UP DATE | 22.02.2002 | MORE DETAILS | omglobalinvestors.com |
| MANAGER START DATE | 31.12.2008 |
Source: Old Mutual Global Investors as at 31.07.2018, *Morningstar as at 28.08.2018
Performance
| Fund/Index | 1-year total return (%) | 3-year cumulative return (%) | 5-year cumulative return (%) |
| Old Mutual UK Mid Cap Fund | 6.82 | 56.10 | 111.35 |
| FTSE 250 ex-IT index | 7.86 | 29.92 | 58.07 |
| FTSE All-Share index | 6.82 | 37.07 | 45.65 |
| IA UK All Companies sector average | 6.83 | 33.89 | 47.23 |
Source: FE Analytics, as at 27.08.2018
Top 10 holdings as at 31.07.2018 (%)
| boohoo | 6.8 |
| Ascential | 5.4 |
| Fevertree Drinks | 4.7 |
| SSP | 4.3 |
| Ashtead | 4.0 |
| GVC Holdings | 4.0 |
| HomeServe | 3.6 |
| Indivior | 3.4 |
| Workspace | 3.4 |
| 3i | 3.3 |
Source: Old Mutual Global Investors
Sector breakdown as at 31.07.2018 (%)
| Industrials | 25.8 |
| Consumer services | 25.4 |
| Financials | 22.3 |
| Consumer goods | 11.5 |
| Healthcare | 3.4 |
| Technology | 2.7 |
| Basic materials | 2.0 |
| Telecommunications | 0.8 |
| Unlisted | 4.0 |
| Unclassified | 0.9 |
| Cash | 1.3 |
Source: Old Mutual Global Investors
