Investors wary as UK election looms

Stock picking is the key to investing in small- and mid-cap companies, but understanding how the economic environment will impact these stocks will help investors to make the right selections for their portfolio.

In the UK, speculation surrounding the upcoming elections and which parties will win a majority are creating uncertainty for small and mid-cap investors.

Richard Bullas, portfolio manager of the Franklin UK Smaller Companies fund, says: “The biggest uncertainty for the UK market in general – not just mid and small caps – is the looming election. This affects the whole market and it’s certainly on top of investors’ minds as we run up to May.

“I think we can navigate it reasonably well; it just may mean business investment decisions are prolonged a little bit.”

Peter Ewins, manager of the F&C Global Smaller Companies investment trust, suggests: “We feel consumer-orientated stocks should perform better [in the UK this year]. While there is election uncertainty, the fall in energy and food prices – plus rising employment levels – are helpful influences for companies exposed to the domestic spend.

“Stocks with high-export dependence on Europe will see a hit to their earnings from currency moves, but hopefully the European macro scene will improve as the quantitative easing [QE] move starts to feed through later in the year.”

Paul Spencer, portfolio manager of the Franklin UK Mid Cap fund, adds: “I think you have to look at your end markets and realise that both small- and mid-cap [stocks] are very diverse and you have to pick your way through the sectors.

“The UK is a fairly diverse set of industries, but those that are consumer facing probably have a better outlook than they did last year.”

Europe’s economic backdrop remains shaky for the region’s small- and mid-cap investors, in spite of Mario Draghi’s announcement in January of a programme of QE. The European Central Bank (ECB) will pump €60bn (£45.2bn) a month into the eurozone economy, starting in March until the end of 2016.

Anna Stupnytska, global economist at Fidelity Worldwide Investment, predicts: “With the ECB unveiling an ambitious QE programme at its January meeting, further weakness in the euro and lower yields should help growth rebound throughout the year. In addition, lower energy prices and a lower fiscal drag should provide further support.

“Just as elsewhere, there are lags involved, and a more self-sustained [even if modest] recovery is unlikely before the second half of 2015. In the meantime, uncertainty around the Greek situation and the risk of the Russian domestic crisis intensifying [and spilling over through finance channels] will continue.”

Remi Ajewole and Urs Duss, both multi-asset fund managers at Schroders, think the global recovery will continue this year, but they warn of “sizeable” headwinds – namely, the slowdown in China, the “dollar squeeze” and the possibility of deflation in Europe.

Ms Ajewole and Mr Duss observe: “The US economy is currently the main growth engine for the global economy. Therefore, the big question is whether the slowdown in other parts of the world will contaminate the recovery in the US.

“We believe the improvements in the US labour market will be maintained, and view the recent decline in the price of oil as beneficial for the US consumer. However, our fear is that the risk emanating from the other economies, the severity of the oil decline and the strength of the dollar could all have a destabilising effect on financial markets.”

They point out that in the past 12 months earnings have made a “meaningful contribution” to overall equity returns.

But they warn: “Macroeconomic uncertainty has begun creeping into the outlook for corporate earnings. Unlike previous years, the outlook for earnings is no longer so clear cut. This is particularly true in the US where the breadth of analysts’ estimates has been increasing.”

Mr Ewins thinks the risks to small- and mid-cap investors lie elsewhere. “What would not help would be further turmoil in Europe post the Greek news and/or signs of financial stress in China or a material slowdown in the US,” he explains.

“With the oil price effect likely to lift economies in most parts of the world this year, and QE ongoing/starting up in Japan and Europe, we hope to see better returns in 2015 than there was in 2014.”

Ellie Duncan is deputy features editor at Investment Adviser