F&C manager Catherine Stanley (pictured) believes UK Smaller Companies are in a ‘perfect storm’ following shaky economic data and the relative outperformance of mega caps.
The Citywire A-rated manager said she is not fazed by the recent violent rotation out of small and mid caps, given their exceptional performance over the past few years. The FTSE Smaller Cap ex ITs index has risen by 144% over five years to the end of May, compared to the FTSE 100’s 16.11% rise.
‘It’s not hugely surprising, given the strong run we have seen, and there are a number of other factors. People started to get worried about recovery around the world, and smaller companies tend to be correlated to economic activity,’ she said.
At the same time, she said the sheer number of initial public offerings (IPOs) has drained money out of the UK Smaller Companies sector.
‘The level of IPOs we have seen takes up huge amounts of our time and energy. Even if you don’t take them on, it costs a lot of cash, so there is not enough for people to start topping up their holdings,’ she said.
‘All these are technical factors. The IPOs, the large cap M&A and the economy, it’s a bit of a perfect storm. I know from speaking to my peers that we are short of cash.’
Stanley has been selective over which IPOs she has backed in her F&C UK Smaller Companies fund.
‘We are really only interested in companies where we have been able to meet with management teams and that are committed in the long term to being quoted and understand what that means for them,’ she said.
‘Lots of businesses have got either very short track records or are private equity companies where we do not know if the management team are committed to being quoted.’
Backing Cambian Group
One business the fund did decide to invest in was Cambian Group, which provides rehabilitation centres for adults and children largely off the back of NHS referrals.
Stanley said she was heartened by the fact the business has very strong clinical outcomes relative to the NHS, with a management team that has been in the field for a decade and made themselves very accountable.
She said that while Cambian was ‘not a bargain’, it is a high growth stock. Other IPOs, particularly in retail, looked expensive.
The IPO market could be set to quieten down over the next few months and Stanley suggested we ‘absolutely need to have a pause’ to see where markets are at the end of the summer.
She also noted that a few placings have already been scrapped as investors ‘ran out of cash and appetite’.
Awaiting Q2 results
A common concern for investment managers at the moment is whether companies’ second quarter earnings will come through to justify their rerating, after figures for the first quarter disappointed.
But Stanley noted one positive from the recent volatility is that the stretch in valuations has become less severe.
Looking ahead, the manager said there could be some issues around potential interest rate rises although she is not unduly worried. ‘Obviously there is the interest rate rise issue and the timing of that but we are hoping we have talked about it so much it will be a non-event,’ she said.
‘Sectors like housebuilders could take a hit, but the housing shortage will still be there,’ she added.
While Stanley has taken profits from some of the housebuilders, she has stuck with firms such as eighth biggest holding Galliford Try, which she said is committed to returning cash to shareholders rather than trying to grow into a major player in the sector.
She also thinks outsourcing companies could be negatively affected by next year’s general election, which typically means the government does not embark on any big projects as the parties are busy campaigning.
Over the three years to the end of May, the £121.9 million F&C UK Smaller Companies fund has returned 58.4%, compared with an average of 48.7% for its Citywire UK Equities peer group. Over five years, the fund has risen by 175.7% compared with 156.6% for the peer group.