Long Read  

An uncertain mixture of threats

The hope being that this feeds through to lower inflation and less pressure to raise rates – benefiting quality growth companies, which retain those strong balance sheets I mentioned earlier.  Even if consolidation does occur, this will allow certain mid caps to take advantage.

It is a similar story for UK small caps, which have already demonstrated tremendous resilience throughout the uncertainties of Brexit and Covid.

A recent research update from Franklin Templeton says UK small caps are currently pricing in a lot of downgrades, with investor sentiment swinging to pessimism – as a result the team are finding opportunities in four specific market areas: digital economy, decarbonisation, consumer brands and content and IP creation.

A lot of this all boils down to balance sheet strength – these companies have the ability to tap into opportunities in uncertain times. For example, the Liontrust UK Micro Cap fund only invests in companies that are profitable at the time of their initial investment.

Good examples are companies like corporate training business Mind Gym and online music retailer Gear4Music, where their respective owners invested in their business during uncertain times to generate long-term growth.

History shows us that small and mid caps historically lead recoveries in markets – we also must remember that when you read about the history of recessions, the market can spend 12-15 months falling and then unwind all that negative performance in two or three months. An allocation to these areas might mean some more pain now but a lot less in the future.

Three funds to consider:

AXA Framlington UK Mid Cap 

Managed by Chris St John, the AXA Framlington UK Mid Cap fund targets UK companies that are benefiting from structural tailwinds. St John will look for companies that are high quality (both financially and in terms of their management teams) that can show sustained profitability, and that exhibit future growth potential. He is also pragmatic about including select opportunities from the smaller companies space.

IFSL Marlborough Special Situations

Manager Eustace Santa Barbara looks to build a well-diversified portfolio of 150 stocks to minimise risk. Relatively small positions are taken initially, with winners run aggressively as their story unfolds. The fund has evolved as it has grown over the years and now invests in small and medium-sized companies. Long-term performance has been exceptional.

TB Amati UK Smaller Companies

This fund is managed by a highly experienced quintet of small-cap specialists. The portfolio of 65-70 companies focuses on structural growth businesses, which the managers say can add value in the under-researched small and mid-cap part of the market. Valuation is important, and the managers love to buy cheap businesses when they can, but they think it is much more important to find the right companies first.