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Behind the 'cloudy' outlook for the UK

30 May 2018

This article first appeared in Investment Week.

Read almost any headline on the investment prospects for the UK, and it will likely paint an extremely cloudy picture. Political uncertainty is a constant feature, and the US dollar, which provided an earnings tailwind for overseas earners throughout 2017, has now become a headwind. Retailers are still suffering from cost inflation and weaker consumer spending, with the poor spring weather frequently cited as a further nail in the coffin.

While smaller companies are often seen as more vulnerable than large caps to many of these headwinds, this is not the case. The Alternative Investment Market (AIM) is no longer the domestically focused market that many people perceive it to be. Most companies we speak to have sophisticated currency hedging strategies in place, while the reduction in US corporation tax has also helped to offset foreign exchange risk. Many companies also had a very buoyant reporting season, and are confident about international growth opportunities. It’s the businesses which are thinking globally that are on a strong earnings path.

M&A activity in the small cap sector remains strong, and we expect that to continue, with tech M&A particularly active. Many of these bids are also coming from unusual sources. Both FreeAgent holdings plc, the accounting software provider, and Vipera plc, the mobile financial services provider have announced takeover approaches from high street banks, as they seek to broaden out their SME & consumer offering in order to retain clients. This activity suggests both investor and corporate confidence remains intact.

While the retail sector in the UK is not viewed as a particularly bright spot, with profit warnings from some of the traditional high street players, we haven’t sidestepped the sector. Instead, we focus on retail companies that don’t have the cumbersome overheads of the high street stores and that are well positioned to benefit from the shift to online sales. Angling Direct plc and Gear4Music holdings plc are two great examples of businesses with sophisticated online offerings in sectors filled with independent stores. This makes them ripe for consolidation and enables effective online players to take a dominant market share.

While the UK may be broadly out of favour with international investors, we do not share this sentiment. We continue to see exciting opportunities at the smaller end of the market, underpinned by healthy fundraising activity.

Bull points:

  • M&A in the small cap sector remains strong
  • Smaller companies have had a buoyant reporting season, with good global growth prospects

Bear points:

  • Retailers are still suffering from cost inflation and weaker consumer spending
  • US dollar has become a headwind for overseas earners

For journalists in their professional capacity only. The value of an investment, and any income from it, can fall as well as rise. Investors may not get back the full amount they invest. Personal opinions may change and should not be seen as advice or a recommendation. We do not offer investment or tax advice. We recommend investors seek professional advice before deciding to invest. Investors should read the product brochure before deciding to invest. This is available at octopusinvestments.com. Issued by Octopus Investments Limited, which is authorised and regulated by the Financial Conduct Authority. Registered office: 33 Holborn, London, EC1N 2HT. Registered in England and Wales No. 03942880. Issued: May 2018.