Investors have started to show renewed confidence in UK equity funds following years of Brexit-related outflows and invested a net £1.3bn in them during December 2019, according to the Investment Association. The surge back into UK equity funds may have been triggered by the outcome of December’s general election and a sense of reduced uncertainty around Brexit. However, some of those who invest directly in UK equities are more cautious.
Such investors include Anna Macdonald, co-manager of TB Amati UK Smaller Companies Fund (GB00B2NG4R39), who had been growing more confident about the UK market in the months before the election when Boris Johnson first appeared to be making more progress with his Brexit plans. That confidence rose further with the election result, but she warns it was no “slam dunk”, given the uncertainties that remain in the year ahead.
“The election result highlighted things that had been erroneously oversold where there was still a good structural reason to own them,” she says. “You have had asset allocators saying let’s look at the UK. But you can’t say the Brexit risk has passed.”
This mindset may explain why Ms Macdonald, and the fund's co-managers Paul Jourdan and David Stevenson, have been marginally increasing their exposure to companies with a focus on the domestic economy, but are not making a big bet on this area. There is now a 50/50 split between this fund’s domestic and overseas exposure.
Its managers have been adding to positions in housebuilders such as Redrow (RDW) and MJ Gleeson (GLE) – two of the fund’s 10 biggest holdings at the end of 2019 – and Grainger (GRI).
Ms Macdonald likes the fact that these companies have “significant exposure” to the rented sector. But she also believes that customers of companies such as MJ Gleeson may feel optimistic about recent events, potentially boosting the company’s fortunes.
“Some 75 per cent of MJ Gleeson customers voted for Brexit,” she says. “It is exposed to the 'red wall' [former Labour voters who voted Conservative in the last election].”
Political developments could also aid other holdings. Ms Macdonald argues that Hollywood Bowl (BOWL), which was added to the fund last year, and Gym Group (GYM) could fare well in the event of an increase in the minimum wage, something recently mooted by the chancellor in advance of the March Budget.
“We know [chancellor] Sajid Javid has pre-announced a mini wage increase,” she says. “We think consumer-exposed stocks might bounce from that and more Brexit certainty.”
And she argues that wage increases should have less of a negative impact on these two businesses than in other sectors.
“Wages as a proportion of costs are in the mid to high single digits," she explains. "But for a restaurant it’s 20 to 30 per cent. With Gym Group you pay a low monthly subscription. There’s lots of mid-market gyms to eat away at. You have a nice clean gym, but don’t get a fluffy towel so bring your own."
The fund was well diversified with 71 holdings at the end of last year, for a good reason. Brexit poses a risk to companies with domestic exposure, while the coronavirus outbreak and tensions between Iran and the US earlier this year highlight some of the developments that can disrupt overseas revenues. And Ms Macdonald says they have another concern.
“There’s the de-equitisation of the stock market,” she says. “There are so many avenues for tech stocks to get private funding that it reduces your pool of [potential] investments.”
Last year saw the lowest number of UK flotations since 2009. But there are still opportunities. TB Amati UK Smaller Companies' managers participated in Pebble Group's (PEBB) initial public offering (IPO) in early December 2019, and they and other investors negotiated a better price for their shares amid pre-election uncertainty.
“Investor enthusiasm wasn’t what it might have been after the election," says Ms Macdonald. "We reduced the range of the IPO by saying that if they cut the price the order would be more significant. And the shares have risen since the IPO."
Like another of the fund’s holdings, 4imprint (FOUR), Aim-listed Pebble Group focuses on promotional merchandise such as branded umbrellas. However, unlike 4imprint, Pebble Group sells to major corporations including Google (US:GOOG) and Estée Lauder (US:EL).
Recent disposals from the fund include Keywords Studios (KWS). The fund's managers sold it last year because of its valuation and to enable them to invest in Sumo Group (SUMO), which focuses on video game development. Ms Macdonald says that because inflows were coming into the fund they reduced the holding in Keywords Studios before selling it outright. This has meant that the fund’s cash level, which normally stands at around 5 per cent and was as high as 10 per cent before the election, has been limited.
