Investor sentiment in the UK is at a record low since 1995 – worse than during the Global Financial Crisis. This negative environment has reshaped the market, de-rating businesses across the board. However, pessimism can be advantageous to long-term active managers, creating opportunities to pick up high-quality growth companies at attractive valuations.
Inflection points, where investors exercise excessive caution, help bring about those opportunities because they bring volatility to the markets. For the active manager who has put in months or even years of forensic company research and engagement in order to uncover their next investment idea, these inflection points are the perfect opportunity to establish those new positions at a more attractive price point. Brexit may prove to be an example of this.
Ultimately, the UK domestic stocks currently so unpopular with investors will rerate, barring unrelated company-specific headwinds. And sentiment could flip quite quickly – any guarantee of medium-term certainty would boost markets, rewarding small and mid-caps where growing dividends and room for capital growth can be found. Our job is to make sure we buy in before this happens, so we are in a position to benefit from the eventual turnaround.
remain positive on the year ahead, despite potential bumps along the road. We
continue to be focused on identifying high quality growth businesses with good
cash flow, strong margins and returns on capital. These qualities are the first
thing we look for, before we consider an appropriate valuation.
One company we
have been monitoring for some time was Gooch & Housego, a global leader in
optics and photonics technology. It is one of only a few high-tech firms in the
world to manufacture lenses for specialist applications and lasers. Despite its
market-leading position in this niche industry and a strong management team,
the company has become unloved in the last six months for no reason other than
poor sentiment in UK small and mid-caps. We have now started to build a small
position, taking advantage of such short-termism.
company we have followed for some time, seeking an attractive entry point is
Tracsis, a company specialising in software for the rail and transport
industries. Based in Leeds, the company combines rail and software expertise
across the UK, supplying not only the rail operating companies but Network Rail
with arrange of critical operational solutions. Many of these are applicable to
foreign markets as well as demonstrated by its recent contract win with CSX in
the US. Strong cash flow and a cash rich balance sheet is enabling the business
to seek new attractive acquisition opportunities which abound in this niche
will always be political uncertainties to contend with, of which Brexit is one,
however most of our holdings are international players with diversified
exposures. For these companies, the UK market is relatively small, and
potentially bigger problems such as President Trump’s trade tariffs and
political uncertainty in Europe are of greater concern. Moreover, if the pound
comes under pressure, exporters will be rewarded.
Still, all of
our holdings have taken Brexit uncertainty on board, putting contingency plans
in place with modest stock builds or other operational fixes. Companies are
focused on growing their businesses – they are opportunistic and
entrepreneurial and work around these issues when given enough time. For
example, most of those companies we invest in mechanically hedge against
currency risk. Where the opportunity to add alpha lies is among those names
that have been indiscriminately sold down; this is where Brexit has provided a
golden opportunity for active managers.