Brexit is Challenge for Small Company Stock Investors

Over the past four years small and mid-sized companies have outperformed their larger counterparts, helping boost flexible portfolios. Will the Brexit vote knock them off course?

Emma Wall 8 March, 2016 | 9:45AM
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Emma Wall: Hello and welcome to the Morningstar Series 'Why Should I Invest With You?' I Emma Wall and I'm joined today by Katen Patel, Manager of the JPMorgan Smaller Companies Trust (JMI).

Hi, Katen.

Katen Patel: Good afternoon.

Wall: So small and mid-cap has been really great place to be over the last four years. I have been a beneficiary of it in my SIPP in fact, but all good things must come to an end. So I suppose the question is how long can this rally continue.

Patel: Sure, well the outperformance of the small and mid-cap company sector has been driven by two features really. The first of which is the focus on the domestic economy, so the small and mid-cap sector generating 50% of its revenues from the U.K. market versus large cap peers that are generating almost 70% of their revenues from the overseas markets. So the continued revival we've seen in the U.K. economy has benefitted those parts of the market disproportionately I guess.

The second key area is the lower exposure to some very weak areas of the market, such as oil and gas and mining. As you know the large cap stocks are very heavily focused to these areas of the market that being weak on the back of some very weak commodity prices and again that’s driven the underperformance of large cap versus small and mid-cap stocks. Looking out to the longer term, if you look back at some of the Numis data going back to the 1950s; while small and mid-cap stocks don’t outperform in every single year, they do tend to outperform in two out of every three years which is a considerable number.

So, that, I think in part is driven by their ability to be more nimble when conditions change and more niche and growth focused and that leads to probably outperformance continuing in to the longer term I suspect.

Wall: So you've mentioned there that the U.K. economy is – economic health is linked to the sort of performance of small and mid-cap. We look to be in quite a good place with the U.K. economy. I suppose the only cloud on the horizon is June 23rd where we will be having a referendum on whether we stay in the EU or vote to go out. As a U.K. small and mid-cap investor how do things like that affect your investment decisions?

Patel: Absolutely that is the key challenge we are looking at this year. In fact it's already caused considerable market volatility and that’s due to the uncertainty firstly around the result and also the potential implications should we vote to leave. And obviously the small and mid-cap sector having higher domestic bias has been impacted more than large cap stocks.

Now, we are doing a lot of work, background work looking at the potential implication. So considering things like high cost of sourcing of goods and particularly when sourced in dollars. Things like higher cost of labor maybe for those sectors exposed to foreign work should immigration curbs come in, or even things like foreign denominated debt which is set against domestic revenues could be an issue.

However the polls and the betting companies still suggest we're going to remain within the EU therefore we haven’t made any changes as yet. However the increased volatility also provides some opportunities and lot of stocks also get caught up in the noise around the EU vote and potential implications and that creates mispricing opportunities as well. And we've managed to benefit in some instances and we're focusing on obviously attractively valued companies, high cash flow generation, good balance sheets with exciting growth prospects and I suspect as volatility continues we'll find more of these opportunities.

Wall: That sounds a bit like you are sector agnostic. You are just looking there for those underlying things within a balance sheet. Is that fair to say that’s actually where you are looking for opportunities, is less about what the company is and does, its more about what its figures look like?

Patel: Yes, absolutely. So we are completely sector agnostic and we'll consider investments in each and every sector and obviously there will be sectors which are more attractive at any one point, but that’s very much driven by the bottom up stock selection. And as I say a focus on the actual earnings and what they are delivering rather than the story behind it.

Wall: Katen, thank you very much.

Patel: Thank you.

Wall: This is Emma Wall for Morningstar. Thank you for watching.

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Securities Mentioned in Article

Security NamePriceChange (%)Morningstar
JPMorgan UK Smaller Companies Ord299.00 GBX-0.33Rating

About Author

Emma Wall  is former Senior International Editor for Morningstar

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