Hidden gems abound amid British bounce back

While the last few years have presented significant challenges for British businesses – with headwinds such as Brexit and coronavirus driving the market to a historic 30-year discount – astute investors have been able to access high-quality companies at compelling valuations.

Owing to a successful vaccine roll-out and the conclusion of a post-Brexit trade deal, the UK economy has finally snapped back. This signals a directionally positive environment for UK equities, and is leading allocators to increase exposure to the UK – narrowing the discounts on offer.

Despite investor attention having returned, we believe it is possible to unearth hidden growth gems. The UK recovery will not follow a straight line, and the market will likely be sentiment driven – suffering pullbacks and wobbles on news of new Covid variants or central bank signals. For investors able to ignore the noise, this breeds tremendous opportunity.

  Take advantage of volatility

Prior to the pandemic, the FTSE 250 was expensive relative to other indices, with mid caps touted as the engine of British growth. Identifying high-quality smaller companies at attractive prices was comparatively easy, as small caps traded at a deep discount to the wider UK market.

As Covid-19 severely disrupted most businesses, it created attractive entry points in the mid and large-cap spaces as well. For example, we took advantage of the pandemic’s impact on Moneysupermarket.com to purchase a stake in the leading mid-cap name. The price comparison site – which hosts a range of products, including car and travel insurance, mortgages and loans – suffered a setback due to its travel-related business, but remains highly cash generative.

Counting the group’s former chairman among the key advisers in our network allowed us to gain insight into the company’s culture and strategy over the last decade and gave us the confidence the company will continue to deliver sustainable growth and dividends. Investors in this well-run business should see short-term recovery upside, as well as long-term growth and resilience thanks to its proven balance sheet strength.

The pandemic shock to valuations also provided us with the opportunity to buy into 3i, a FTSE 100 private equity and venture capital firm. The London-based business – which operates in a sector we are familiar with due to our own operations – featured in our model portfolio prior to the launch of the fund, but did not make the final cut, as its yield compressed in the run-up to the launch.

Nevertheless, we kept tabs on 3i, and last year were able to buy into the business at a 6% dividend yield, as its share price took a knock from the pandemic. The group’s largest balance sheet investment is in value retail, which we identified as better able to withstand the pandemic, with many stores deemed ‘essential’ and permitted to remain open during lockdowns. The cash generated from 3i’s investments filtered back into its balance sheet and supported dividend payments.

  Look for long-term growth

As the economy recovers and valuations of UK equities are lifted, it is important to look across the market-cap spectrum for high-quality businesses displaying strong growth dynamics and resilient income. Hidden income generating gems come in all sizes, although we often find these companies in capital-light sectors more insulated from market shocks.

Inspired plc is one such small cap operating in a niche area. The leading UK corporate energy services and procurement specialist took a hit from the pandemic, with a segment of its customer base in the retail and hospitality sectors.

However, having first invested in the business in 2011, we knew the company possessed the management capability and structural growth potential to outlast the pandemic-induced disruption. By working closely with management and key stakeholders over the years, we support the strategy to shift the company’s focus from lowering energy bills to reducing carbon emissions – to capitalise on the growing sustainability agenda.

Leveraging the wealth of data and analysis it has collected to-date, Inspired plc is now building out its offering with a new business arm, which provides ESG data and analytics for businesses conducting supply chain evaluations. Due to the profit recovery potential and long-term structural growth opportunity tied to this expanding sustainability offering, we invested further in the company during the Covid dip and hold a significant stake in the business across our strategies.

Overall the pandemic validated our process of focusing on robust groups strategically positioned for long-term growth as shown by the resilience of our dividend in 2020. For investors prepared to put in the time to track quality companies and capitalise on dips in the market, the UK remains a fruitful hunting ground. If anything, Covid-19 has opened up greater opportunities to uncover underappreciated gems across the market cap spectrum.

Ken Wotton

Managing Director, Public Equity

Ken is lead manager for the LF Gresham House UK Micro Cap Fund, LF Gresham House UK Multi Cap Income Fund, Strategic Equity Capital plc and AIM-listed portfolios on behalf of the Baronsmead VCTs.

Ken graduated from Brasenose College, Oxford, before qualifying as a Chartered Accountant with KPMG. He was an equity research analyst with Commerzbank and then Evolution Securities prior to spending the past 12 years as a Fund Manager at Livingbridge and now Gresham House specialising in smaller companies.

Key risks

• The value of the Fund and the income from it is not guaranteed and may fall as well as rise. As your capital is at risk you may get back less than you originally invested
• Past performance is not a reliable indicator of future performance
• Funds investing in smaller companies may carry a higher degree of risk than funds investing in larger companies. The shares of smaller companies may be less liquid than securities in larger companies

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Gresham House is authorised and regulated by the Financial Conduct Authority.

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