Challenger comebacks

Things can turn around in absolutely no time at all. That thought struck me as I watched Coventry City equalise against Manchester United in the FA Cup semi-final the other weekend. Three goals down with 20 minutes to go against one of the nation’s biggest fish, a middling team was completely written off by everyone. And then, lightning struck.  

While they were cruelly denied a win by VAR, Coventry certainly showed that they were just as deserving to play at the top level of the game. Size, money and brand certainly help – but they aren’t everything. That certainly goes for smaller and mid-sized UK companies as well. Everyone at the top had to start from the bottom at some point – Coventry themselves were in League Two as recently as 2018. And there are plenty of once-great British businesses that have fallen from grace and given way to challengers.

The UK market as a whole has been a global underdog for several years now, shunned by investors who have clamoured for the mega-cap businesses astride the US stock market. Yet over the past three years, small and mid-sized British companies have lagged their large-cap UK peers by a whopping 30%. And that’s an improvement on six months ago, after a decent run for smaller UK companies relative to the FTSE 100.

Lots of value below the surface of the UK

Our penchant for ‘quality growth’ companies (those whose profits are increasing strongly and steadily, and therefore are relatively expensive), has helped fund performance lately. So too has a bias toward industrial businesses – the manufacturers in our economy.

It’s been a bumpy ride as forecasts of US interest rates have fluctuated massively. Nonetheless, the strength of the US economy – the reason why rates over the Atlantic are expected to stay higher for longer – and the brightening outlook for the UK is a good thing for company profits. Especially for those companies that aren’t big borrowers (around 40% of our fund’s holdings have more cash in their accounts than any debt they owe), as they get the benefit of better sales without the financial squeeze further down the income statement.  

The UK market trades on a record discount to the US, yet no longer looks like an economic outlier. With the Magnificent Seven driving such narrow returns globally, it makes sense that investors are increasingly looking for some alternatives for fresh capital. Buying ‘quality growth’ businesses trading at prices that are a ‘value’ multiple of earnings in a stable economy could look like a good choice. Indeed, we hear more market commentators, with no axe to grind, talking up the UK, particularly mid-caps. We are, of course, in violent agreement.  

We think there’s lots of value lurking below the surface here in Britain, but investor attention has been squarely elsewhere. We think that situation must change at some point. And like Coventry’s comeback against a huge, dominant rival, that might take no time at all.