UK equities are out of favour among international investors, but foreign companies are comfortable enough with the UK’s long-term future to buy up British businesses – at attractive valuations. Neil Hermon, fund manager of Henderson Smaller Companies Investment Trust, explains why.
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Away from the media circus surrounding the UK’s exit negotiations with the EU, overseas companies are quietly taking advantage of the pessimism towards UK equities by buying British businesses at attractive valuations.
Overseas companies are seeing value in the UK; in fact 2017 was the first year since 2011 in which British companies saw a net increase in direct foreign investment. The trend can be seen building from 2015, when there were 145 merger and acquisition (M&A) deals involving overseas investors (inward M&A). In 2016, inward M&A deals increased 80% to 262 and in 2017 there were 259.
The first quarter of 2018 followed suit with 75 deals and Q2 statistics show 182 completed inward M&A deals – although this increase is mainly a result of a new methodology for collecting M&A data by the UK’s Office for National Statistics, namely around capturing smaller company deals.
The numbers suggest that if we don’t notice the value in UK equity markets, others will. Henderson Smaller Companies Investment Trust has been a big beneficiary of this trend, with small and medium-sized companies in the UK attracting the interest of overseas companies.
Since January 2017, the Trust has profited from 10 M&A deals whereby a company we held in the portfolio was acquired, with seven of those deals involving an overseas buyer.
A recent example of such corporate activity is US private equity firm Silver Lake Partners’ takeover of ZPG Group, which owns property website Zoopla and price comparison service uSwitch. We bought ZPG at 332p per share in January 2017 and sold it for 489p in June, representing a total return of 42.9% over the 18-month period.
Another example is Fenner, a polymer technology firm that provides engineering solutions across a variety of markets. The company was acquired by French conglomerate Michelin this summer for about £1.2bn. We first bought a position in Fenner in April 2017 at 316p and sold it for 609p, representing a total return of 82% in just over 12 months.
These examples demonstrate not only the opportunities for growth investors in the UK’s small and mid-cap markets, but also the confidence overseas investors have in British companies. That message is easily lost amid the furore of Brexit, but there are good reasons why global investors are putting money in the UK.
A Great British brand
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The UK is a well established brand with a long history of international trade, and it was considered the easiest place in Europe to do business in the World Bank’s Doing Businessreport. We have a strong rule of law that shields British businesses from corruption and criminality, and will remain a strength of UK corporate culture when it leaves Europe’s political union.
The UK is home to some of the best universities in the world and leads in Europe as the number one destination for higher education. This means UK companies are well placed to recruit top talent from around the world. The country’s central geographic location helped it to become a global superpower, and this could be a supportive factor in developing a new network of trade agreements.
Sterling may have suffered since the referendum – and it could become a source of further frustration as the months roll on – but it remains one of the UK’s strengths. An independent currency and central bank working towards a resilient and robust economy is a huge positive as the UK undergoes this transitional period.
Big opportunities in smaller companies
We think now is a good time to buy UK small and mid-cap. Valuations are certainly reasonable; the UK market is cheap by international standards and offers good value relative to historic levels.
We are mindful of the UK’s situation with Brexit negotiations entering their final stages. We might see the UK economy do well or badly on the back of the Brexit deal, which is why the Trust’s portfolio is geographically diverse in terms of revenues; almost half of the sales made by the portfolio companies go overseas. This diversification, we think, is important as we edge closer to the Brexit deadline.
Henderson Smaller Companies Investment Trust has a strong growth bias and a track record of delivering superior total returns for shareholders over a medium to long-term horizon. In fact, the Trust has outperformed the Numis Smaller Companies Index on a total return basis in 14 of the past 15 financial years.
A £1,000 lump sum investment in the Trust on 31 October 2002 would now be worth £12,577 (as at 30 October 2018), with a compound return of 17.4%. That’s not to say we are going to live off past glories, because they won’t guarantee future results, but we will continue to employ the same principles and consistent strategy that has rewarded our shareholders.
About Neil Hermon
Neil Hermon is Director of UK Equities at Janus Henderson Investors, a position he has held since 2013. Neil is also a Fund Manager on the International Long/Short Equity strategy. Neil joined Henderson in 2002 as head of UK smaller companies and Fund Manager of Henderson Smaller Companies Investment Trust. Prior to Henderson, he served as head of UK smaller companies for General Accident Investment Management (later to become CGU plc). He began his career at Ernst & Young as a chartered accountant. Neil graduated from Cambridge University with a MA (Hons) in mathematics. He is an associate of the Institute of Chartered Accountants of Scotland (CA) and an associate member of the UK Society of Investment Professionals (UKSIP), and has 29 years of financial industry experience.
Before investing in an investment trust referred to in this article, you should satisfy yourself as to its suitability and the risks involved, you may wish to consult a financial adviser. Past performance is not a guide to future performance. The value of an investment and the income from it can fall as well as rise and you may not get back the amount originally invested. Nothing in this article is intended to or should be construed as advice. This article is not a recommendation to sell or purchase any investment. It does not form part of any contract for the sale or purchase of any investment.
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