Closed-end funds invested in small and mid-cap stocks have dropped in price since the Brexit vote was revealed last week, creating an opportunity for the brave contrarian investor.
It is little surprise to see those stocks deemed to have substantial UK exposure suffer subsequent to the recent EU referendum result. Whilst the UK may avoid outright recession, the current modest rate of growth will at the very least be paired back, as investment decisions continue are deferred and the consumer potentially retrenches.
Since June 23 mid and small cap closed-end funds, seen as most exposed directly to the domestic UK economy, have fared worse than their larger cap brethren which derive substantially more of their earnings internationally.
JPMorgan Mid Cap (JMF) initially fell nearly 20% in value although has rallied subsequently and is 10% down on last week. Standard Life UK Smaller Companies (SLS) and Schroder Mid Cap (SCP) have also fared poorly.
Our analysis suggests that the average exposure to UK listed companies is broadly 95% within the universe of large, mid and small cap funds but this does not shed any light on where the underlying holdings derive their earnings.
Property Brings Down Trusts’ Share Price
Turning to industry exposure the small and mid-cap peer group’s weightings to the domestically focused banks is modest compared to the large cap peer group as may be expected, however weightings to Real Estate Investment Trusts and Real Estate Management & Development, which is arguably the ultimate UK domestic play, is far more material within the small and mid-cap peer group.
Mid and Small cap funds are also less represented in classically defensive sectors such as tobacco or pharmaceuticals. An element of gearing within the closed ended structure will also be an additional factor that will likely acerbate negative returns in a market sell off so compounding adverse investor sentiment in these areas.
For all of this the discounts that small and mid-cap focused trusts are currently trading on is only modestly wider than their recent averages suggesting that investors are, in general, taking a relatively sanguine view of the outlook for such investments for the time being.
Buying Opportunity?
A recent report from Stifel Funds suggests that any UK exit from the EU will take until 2019 at the earliest, if at all.
“Whatever the many scenarios, in the meantime corporates will be focused on profitability and trying to make the most of lower sterling and other opportunities that may arise post-referendum. The managers of the listed funds are also taking advantage of investment opportunities, despite the ‘political noise’,” it reads.
“Therefore, we think it is worth analysing which funds have been de-rated the most in the post-result hysteria that has impacted some fund sectors. As expected, many of the funds with significant overseas investments have actually seen share price rises in recent days with Sterling weakness being helpful to NAVs.”
