UK listings slow amid 'headscratcher' market valuations

David Elton, manager of the £31.8mn Castlefield Sustainable UK smaller companies fund, said there were "massive spreads and massive variations" occurring between the largest stocks on the FTSE 100 and smaller listed companies, and it was a "bit of a headscratcher right now" in terms of how to make sense of the valuation disconnect.

He told FTAdviser: "Small caps last year had a tough time last year, which expanded the valuation disconnect between small and large-cap stocks, and while there has been a change-around this year, we still cannot believe some of the valuations.

There has been a lot of uncertainty since Brexit, as well as the pandemic and global inflation and events such as the war in Ukraine.David Elton, Castlefield

"Public market valuations cannot stay this way forever - the reality is that levels have to come down in the large-cap space, and small caps have to come back up.

"But while there is this disconnect, there are opportunities for managers to pick up on companies with sustainable business models."

Anomalies

Elton pointed to other anomalies seen in recent years, such as an increase in merger and acquisition activity in 2022 which has started to tail off in 2023, and a slowdown in initial public offerings.

This is happening globally, not just in the UK. Latest figures from Willis Towers Watson showed global M&A Global M&A activity saw a 37 per cent drop in volume during the first half of 2023. The 280 deals completed is the lowest figure for the first half of a year since 2009.

Meanwhile, global IPOs in the first half of this year are far behind levels seen in 2021 and 2022, according to data from EY (see graph).

But Elton said: "We have seen some big-poster names going to the US to list, as well as takeovers and go-privates.

"Markets are challenging and this might make companies more reluctant to float. It's true, at both the small and large end of the market, we are not seeing that flow of IPOs that previously we would see.

"There has been a lot of uncertainty since Brexit, as well as the pandemic and global inflation and events such as the war in Ukraine."

While the company tends not to be early stage investors in new listings - "we would prefer to give up upside potential for more protection on the downside", the manager added: "But there are still great companies out there; global businesses listed in the UK with strong prospects. 

"And despite the valuation frustrations we can see great opportunities."

Top 10 holdings (to end June 2023)

Following the internal 'Best' framework - Business & Finance, Environment, Social and Transparency & Governance - the management team assesses each stock on an ESG and financial risk matrix to see what company would be the best fit for the fund.

He pointed to companies such as Treatt, which creates natural flavours and fragrances for the drinks industry, and plays into Castlefield's environmental, social and governance metrics through the health and wellbeing angle to creating natural, sugar-free flavourings. 

This is one of the top 10 holdings in the portfolio, which at 41 stocks is a concentrated and high conviction-led portfolio. 

Another stock the manager likes, which meets sustainability challenges and presents long-term growth potential, is Blanco Technologies.

This specialises in data erasure software. As a result of being able to purge old devices, the company was able to recycle 55mn devices in 2022.

Tracsis is also in the fund's top 10, another software business that provides software to the rail and transport industry.

But while the fund is high conviction, and the manager likes to "let our winners run", Elton said they did not play favourites with stocks. "We are not big traders, but if we feel the valuation has run too far or a material headwind is developing, we might trim or cut it. 

"That said, these are all businesses we like - or they would not be in the fund any more."

simoney.kyriakou@ft.com