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David Kimberley
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Updated 30 Sep 2022
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Disclaimer

This is not substantive investment research or a research recommendation, as it does not constitute substantive research or analysis. This material should be considered as general market commentary.

In our last blog post we noted that UK equities were looking comparatively cheap compared to their global peers. For the UK, we said, the problems just seem to keep coming and the decline keeps going.

As you may be aware, the intervening period has not seen a reversal of that trend. The pound has hit record lows against the dollar and the Bank of England said it would be printing more money as it continues in its efforts to try and stop printing money.

One of the other points we made in our prior post was that M&A activity remained comparatively high in the first half of this year. A cheap pound, combined with already depressed valuations, has made the companies listed on the London Stock Exchange look more appealing to buyers, whether that be private equity funds or other companies.

Given some of the commentary we’ve seen since the government’s ‘mini budget’ was announced, it is hard to know if that will continue. To read or listen to the various talking heads is to believe that the UK is on the path to emerging market status. Or as former US Secretary of Treasury Larry Summers said, the UK is “turning itself into a submerging market.”

However, it is worth keeping in mind that almost all currencies have seen major devaluations relative to the dollar so far this year. The Swedish Krona, for example, has devalued more than the pound has over the past 12 months. Hong Kong’s authorities have also been buying record amounts of its own currency to sustain its peg with the dollar.

And the same problems the UK is facing are also going to be felt in Europe and other parts of the world. In Poland, for example, the government has already put in place a ‘mortgage holiday’ for borrowers. It is also worth keeping in mind that the UK’s greater energy independence may mean it is less susceptible to some of the problems that other countries could end up facing further down the line.

In short, there isn’t necessarily a lot to be optimistic about the UK in the short term, but there isn’t much reason to be optimistic about many other places too. We are likely in the midst of an unravelling global economic crisis and, although the UK is in the public’s crosshairs now, it is hard to believe other countries won’t be affected as well. But for those that have kept the faith and believe in the UK’s ability to ride out the crisis over the long-run, some interesting options present themselves.

One is Downing Strategic Microcap (DSM), which runs a highly concentrated portfolio, with the managers favouring a value-oriented approach to markets. A couple of things make DSM interesting at the moment.

One is that it had already seen its discount widen substantially in the run up to the problems we’ve faced this year. As a result, its shares have not been hit anywhere near as hard as some of its competitors, because the possibility of poor performance had arguably already been priced in

The other is the value stocks that it invests in are one of the areas that one would expect acquirers to be on the lookout for. And because its portfolio is so concentrated, any acquisitions, assuming they are at a premium, could actually have a meaningful impact on the portfolio.

Another trust that may stand to benefit is Invesco Perpetual UK Smaller Companies (IPU) in this regard. In its 2022 financial year, which ended on 31/01/2022, eight companies, about 10% of the portfolio, was acquired. History may not repeat itself but it seems that the mangers may have something of knack for picking the sorts of businesses favoured by those looking to acquire.

A somewhat similar dynamic may be at play in UK commercial property. These aren’t going to be subject to takeovers. However, like DSM, the discounts on some trusts in this sector are now so wide that there are questions as to what investors can really be pricing in by selling off further.

For example, according to the AIC’s latest data, Balanced Commercial Property is now trading at a nearly 50% discount to its net asset value. This is not to say we’ll see some massive bounce back, with a resulting tightening of the discount. But pricing in a halving of the REIT’s NAV seems like it may act as a cushion to existing problems.


Past performance is not a reliable indicator of future results

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