Eustace Santa Barbara, Co-Manager of the IFSL Marlborough Special Situations Fund, explains why UK smaller companies remain an attractive opportunity despite political indifference and low pension fund allocations.
Cabinet reshuffles are curious affairs. In many ways, when you think about it, there is little obvious logic to them.
The knee-jerk inference when someone is removed from any position is that they must have performed less than satisfactorily. After all, it would make sense to keep them in place if they were doing everything wonderfully well.
So if they are stripped of their duties and then instantly handed another role, as is often the case when a Prime Minister gets the jitters, what grounds are there to believe they will do any better in their new function? Such bizarre career progression is otherwise found only in the wacky world of football management.
The shake-up triggered by Angela Rayner’s recent departure brought a new City Minister. Out went Emma Reynolds, who became Environment Secretary, and in came Lucy Rigby, previously the Solicitor General.
Does this mean anything for investors? Reynolds was a vocal supporter of the UK’s smaller companies, which certainly endeared her to me, but I cannot honestly say whether she did a great job or, indeed, whether her successor will prove superior, worse or much the same.
One thing is for sure, though: it would be useful, to say the least, if someone in Cabinet were to keep banging the drum for British businesses at the lower end of the market-capitalisation spectrum. Why? Because these companies are vital to the country’s economic growth – and growth, lest we forget, is supposedly at the heart of government policy.
Pension reform: a wasted opportunity
The Pensions Scheme Bill underlines the bewildering lack of attention which this corner of the market generates in the corridors of power. Currently snaking its way through Parliament, it represents a classic missed trick.
A report published just over a year ago found UK pension funds’ allocations to UK equities as a whole had fallen to a record low of 4.4% – a percentage beaten by every comparable nation. The figure stood at more than 50% just 25 years ago[1].
Smaller companies have taken a disproportionate hit from this decline, even though a wealth of historical data shows they tend to outperform their larger counterparts over time. Mega-cap US companies have been among the principal beneficiaries of the shift.
Pensions Minister Torsten Bell – a survivor of the post-Rayner game of musical chairs – has spoken of the need to invest “in a wider range of assets”. The goal, he says, is to build a system genuinely capable of “providing a large amount of the financial plumbing our of economy”.
To that end, the Bill features a “backstop” power. It allows the government to mandate that a minimum proportion of large pension schemes be invested in “productive” assets. The purpose, we are told, is to support a “broader agenda of promoting economic growth”.
Yet UK smaller companies – and domestic shares more generally – are not expected to bask in the glow of this provision. The backstop is instead more likely to be used to strong-arm funds into bankrolling the government’s major infrastructure and building projects.
Politicians are best ignored – at least on this point
Ultimately, it is not healthy for fund managers to agonise unduly over such twists and turns. It does us no good to wonder why a Cabinet that claims to have a pro-growth focus does next to nothing to help – or even to highlight – an investment arena in which the prospect of growth is a defining attraction.
We could appeal to Lucy Rigby, of course. It would be heartening to discover she is on our side. But we might also simply accept that life is full of mysteries – and that the government’s narrow outlook in this regard is one of them.
Yet none of this means investors should be similarly unmoved. Notwithstanding Downing Street’s apparent apathy towards it, there are a number reasons to explore the realm of UK smaller companies.
Alongside the potential for long-term growth and outperformance, value is still a key factor. Low valuations have been driving takeovers, share buybacks and returns in this space for several years and may continue to do so even if the overall UK economic picture remains uninspiring.
Relatedly, pre-Budget uncertainty is likely to create buying opportunities. This happened last year, when the AIM “junior” market in particular was caught up in speculation around the scrapping of tax exemptions.
All this underscores that a paucity of top-level endorsement may be frustrating but can nonetheless easily play into the hands of informed investors. Despite our leaders’ indifference towards UK smaller companies, this is a market that still gets my vote.
Eustace Santa Barbara is co-manager of the IFSL Marlborough Special Situations, UK Micro-Cap Growth and Nano-Cap Growth Funds.
