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The 'Brexit' referendum result has dealt a blow to UK smaller companies as investors have shied away from stocks perceived to be exposed to a weakening economy and reduced consumer spending.
In this video interview, Gervais Williams, an experienced smaller companies fund manager, argues many 'small caps' could benefit from a retreat in globalisation that 'Brexit' may inspire.
Moreover, Williams, co-manager of the top-performing Diverse Income (DIVI) investment trust and its more recently launched stalemate, Miton UK MicroCap (MINI), explains that the fall in the pound and a rise in inflation may not be as harmful as has been assumed.
Gavin Lumsden: Hello with me today to discuss ‘Brexit’ and its impact of investors is Gervais Williams, managing director of the Miton Group. Gervais, thanks very much for coming in. Could you start by telling us what are the implications of the decision to leave the European Union?
Gervais Williams: I think the fundamental difference is that actually the trajectory of the UK economy will be different going forward. I think there will still be positive areas but I think the companies which are going to be successful won’t be the same as we’ve had in the past. So perhaps the devaluation of sterling means that manufacturing, those companies supporting manufacturing, those companies competing with imports will do better. Those companies relying on imports, perhaps some of the consumer goods, where perhaps clothing prices increase, maybe we’ll get an increase in petrol prices as well, may find it slightly more difficult. But the opportunity is for the UK to continue to succeed and we’re still upbeat.
GL: OK. One of the notable things about the voting was that people seemed to be voting against their economic self-interest, the economic arguments were being dismissed. What does that tell you?
GW: I think we’ve seen a little bit of a retreat from globalisation. I think that’s really what the main driver of this was. Globalisation of the workforce and I think that’s becoming a bit more control. But actually I don’t think it is entirely against their self-interest. If we get sterling weak, if as an economy we have a little more inflation, actually, how awful is that? That would be quite good for the economy in the longer term.
GL: OK. Now Mark Carney, governor of the Bank of England, was saying the risks for the UK economy were ‘crystallising’. Do you agree?
GW: Well I think there are more risks. I think the UK is a worry but actually I think the international issues are more concerning. We read about the Italian banks and how dangerous they are. We worry about the domino is wobbling in Europe generally, Chinese slowdown still coming through, world growth is stagnating you know, you saw the PMIs from service sector inflation. Again, it’s just not happening elsewhere. We’ve got to find a way to find real growth even when the world is not growing. And that’s why small companies will continue to be successful in my view.
GL: OK well let’s pick up on that because the stock market as a whole had a massive lurch downwards after the referendum result but it then bounced back. But smaller companies have been sold off very aggressively. Two years ago you wrote a book called ‘The Future is Small’. Does that still apply?
GW: Yes, absolutely. That’s all about a retreat from globalisation. Retreat from globalisation has been punctuated by the ‘Brexit’ vote which is another step along the … but the ultimate destination is still very much the same. Share prices are all over the place. It doesn’t mean that’s the finishing post it just means that as active fund managers we’ve got to be in there, getting involved, not just in small companies but companies which are able to generate cash, companies which are able to generate more cash, grow their dividends and see their share prices rise.
GL: This drastic sell-off we’ve seen in smaller companies, is it a massive over-reaction?
GL: Certain stocks are. I think the consumer items are probably going to come under more pressure. As I say if you get rises in inflation then effectively there will be less consumeable expenditure. Perhaps some of the bigger ticket items, maybe housing, maybe cars, maybe expensive holidays, maybe schooling. All of these areas may be more difficult and we’ve seen those share prices really take a caning. Those, along side that, we’ve seen quite a lot of good companies also where the share price has come off a bit but actually where the prospects are still very good. So as an opportunity, we need to re-balance our portfolio a little bit – we’re already largely there to be honest – but we can pick up some of these stocks at distressed prices. And as that dividend growth starts to come through we’ll start to find those share prices start to perform.
GL: So what opportunities has this sell-off created? What have you been looking to buy?
GW: Well it’s quite interesting. Generally it’s companies that are way out of the limelight. The very small companies again is a good area. And what we saw perhaps is the companies which are out of fashion, if they do surprise with dividend growth and they come through. So one of my best performers for our clients in the last couple of weeks has been Stobart Group, which is not well loved by most investors.
GL: What is Stobart?
GW: Stobart is a business involved in biomass. It helps collect shavings and puts them into biomass plants, it also runs Southend airport. It did originally have the Stobart trucking business, but it’s only got about a half of that now. But the main thing is this is a business which generates cash. It doesn’t do it quite as conventionally as many other companies, earnings vary a lot more than other companies but ultimately it generates a lot of cash and it’s generating so much cash it decided to move its dividend yield from a 4 to an 8% yield and grow it from there. The share price has just moved on …
GL: And that’s impressed investors.
GW: That’s what we really need. Companies investing for cash paybacks, productivity improvements at a time when the world is not growing. Small is beautiful and it will continue.
GL: Five-year performance of Diverse Income is good but this year it’s fallen 19% with the sell-off in smaller companies and the shares are actually trading on quite a rare discount, 7% below net asset value as we speak. What do you say to anyone who’s listening to what you’ve said and is thinking this might be a good time to buy Diverse Income.
GW: Well clearly it’s down to individuals to make their individual selections. The key issue is if you’re looking for a fund which is going to generate a good income, which is going to grow its income over time, which is well positioned and diversified across a wide range of companies, of course I think it’s absolutely a fantastic fund. In truth, if we hadn’t set the fund up we would be setting it up now, the opportunity is right there and so we’re very upbeat about the prospects.
GL: Another fund that you did set up a year ago, just over a year ago, is the UK MicroCap Trust. That’s fallen a little bit because it’s been a difficult year but interestingly its shares trade at a very small premium above their net asset value. What’s that saying about investors? Are they in for the long haul on that trust?
GW: Absolutely, the truth is there are very few funds which have a decent weighting to micro. Many of the smaller company funds are quite exposed to the mid cap and the mid cap stocks are, if anything, have been peaking out quite badly, not just because they’ve got quite a lot of consumer goods, they’ve got international earnings as well, but generally nearly everyone has got a full weighting in mid cap holdings. What they haven’t got is a full weighting is small micro. That’s the area where we see the best opportunities, that’s the area which may surprise in terms of low valuations moving up to more medium valuations. That’s the area where we see more dividend growth. And as that comes through clearly we think the MINI fund will continue to do well.
GL: OK Gervais thanks very much.
GW: Thank you very much indeed.