Vantage Point: Investing for Alpha  

What next for UK smaller companies?

James Sullivan, head of partnerships at Tyndall, says: “What we are seeing is UK mid and small-caps trading at multiples of seven of eight times earnings on the stock market, which is very cheap by historical standards, but then being bought and taken private by private equity or other buyers at multiples that can sometimes be twice that level.

"Although mid and small caps are more exposed to the UK economy, the fact good companies are being bought like this shows there are opportunities in the mid and small-cap area.

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"Of course the economic outlook is uncertain, so it is important that investors are very selective. But the valuations at which companies are trading, relative to the valuations at which they are being acquired, is quite a compelling opportunity right now.” 

Despite his keenness on the sector as a whole, McDermott is not looking to increase his exposure to UK smaller companies right now, as a result of the prevailing economic climate.

But it may be a question of timing, according to Simon King, chief investment officer at Vermeer Partners, a wealth management firm.

He says that while the sector looks cheap, it may be that the easiest money has already been made.

King says: “The main issues are that international investors have no interest since they think UK economy is going to hell in a handbasket and the record outflows from unit trusts are making the specialist funds forced sellers to meet redemptions with private clients not interested in taking up the slack.

"History tells us this is exactly the time to be brave, but it may be a little early since we have not yet seen real earnings downgrades. Once they get into full flow then there will be some seriously attractive opportunities. Every small-cap broker in town is running their takeover screens, but a lot of the obvious targets have already gone.”

This could have the long-term impact of meaning the better quality UK small and mid-cap shares leave the UK market and only poorer quality assets remain, making investing in small and mid-cap funds relatively less attractive in future. 

Another investor cautious on the outlook for UK smaller companies is Ben Seager-Scott, head of multi-asset funds at Evelyn Partners, who takes the view that, given the prevailing level of economic uncertainty, it may be too early to decide that the market is cheap.

Seager Scott says: “In aggregate, UK mid caps tend to be more sensitive to the domestic economy than large caps, which are generally more globally exposed, and with the deteriorating outlook for the UK economy they have understandably been coming under pressure.