UK mid-caps can still flourish despite Brexit

 

The referendum result has clearly delivered a shock to the UK economy and will continue to be a source of uncertainty in the near future. However, it is far from a crisis.

While the FTSE 100 quickly shrugged off the Brexit vote, shares of many companies in the mid-cap FTSE 250 index have underperformed large-cap counterparts. There is a good reason for this.  With approximately 72%* of FTSE 100 company earnings coming from outside the UK, against just 41%* for the FTSE 250, the sharp drop for sterling since the Brexit vote has been a key driver of the divergence between the two indices.

Despite this, the most attractive medium to longer term growth opportunities reside towards the lower end of the large-cap index, as well as across the mid-cap spectrum. These areas of the market contain more companies offering structural growth, with an ability to grow faster than the overall market. There is a good reason why the mid-cap index has outperformed the broader market over the long term, with the heavily-researched mega-caps providing little scope for an investor ‘edge’.

There could be challenges in the near term, with fears the UK may now enter recession due to the dent to business and consumer confidence. There is also considerable uncertainty surrounding employment and the UK housing market. This is likely to force authorities to stimulate the economy, with the possible announcement of lower rates and further QE in the coming months. There could also be initiatives to target specific industries, such as the house builders.

While the likelihood of weaker economic growth has risen significantly, companies able to deliver sustainable above-average growth could become increasingly rare and have the potential to re-rate over time. One structural growth theme showing no signs of weakness is the continued online revolution.

Finally, one by-product of this new economic landscape is the possibility of increased M&A activity. With the sharp drop in sterling, international corporates may look to take advantage of ‘on sale’ UK targets. Indeed, we may just have witnessed the first such move, with ARM Holdings earlier this week agreeing to a £24.3bn* takeover by Japanese group SoftBank.

 

*Source: Bloomberg

 

Past performance is not a guide to future performance. The value of investments can fall as well as rise and investors may not get back the amount invested. Income from investments may fluctuate. Currency fluctuations can also affect performance.

This information is for professional advisers only. No guarantee, warranty or representation (express or implied) is given as to the document’s accuracy or completeness. The views expressed in this document are those of the fund manager at the time of publication and are subject to change at any time without notice. The contents of this article are not intended as investment advice. The Canada Life Investments blog page features images licensed from Getty Images International. These images shall not be downloaded, republished, retransmitted, reproduced or otherwise used in any way. Aside from the above, and unless otherwise stated, Canada Life retains copyright in and/or has a right to use all contents of this website (including text and graphics) and such contents shall not be copied, distributed, extracted or modified without the express prior written consent of Canada Life unless for private, non-commercial use.

Nigel Kennett

Nigel Kennett

Senior Fund Manager, UK Equities

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