The UK’s decision to vote Leave sent share prices tumbling, and the more domestically-focused FTSE 250 has been left worst off. Mark Martin, manager of the Neptune UK Mid Cap fund, explains the areas he’s still finding attractive – and the ones he’s avoiding
On the Friday after Brexit, the FTSE 250 mid-cap index had its worst day since Black Monday in 1987, as it fell more than 7 per cent. Prices have since stabilised, but the FTSE 100’s large caps have held up far better – with their multinational operations and foreign earnings which benefit from weaker sterling.
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So after years of relative outperformance, is the party finally over for UK mid-caps? Can only a reversal of the Brexit vote save them? From the way the market has reacted, you’d think this was the case, but to write off the FTSE 250 entirely would be a big mistake.
It’s important to remember that, despite being more domestically-focused overall than the FTSE 100, the FTSE 250 still generates around 50 per cent of its earnings from overseas. Many of our holdings, particularly in the healthcare and industrials sectors, actually stand to benefit from the weakness in sterling through currency-related earnings upgrades.
The panicked reaction to the Brexit vote led to a number of these companies being unduly sold-off, which has actually created a big opportunity for investors to buy specific companies.
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Biotech company Genus, for example, which provides farmers with genetics that enable them to produce animal feed, derives the vast majority of its revenues from outside of the UK. Its share price fell sharply post-vote and has since recovered. In the coming weeks and months, similar opportunities may present themselves.
Admittedly, the uncertainty Brexit has created puts a lot of pressure on domestic cyclicals. While shares in house-builders and property companies have fallen significantly, they are coming down from very high levels, and justifiable concerns over consumer confidence and the direction of house prices makes them too risky. Financials are another area that could be set for prolonged stress as the UK comes to terms with Brexit.
However, the outlook is still bright for a number of non-cyclical domestic companies which have little or no exposure to discretionary spending, such as Telecom Plus, which we have recently added to.
As it is currently trading at around 14.5 times forecast earnings, the FTSE 250 is at its cheapest level since February 2013. This is a 24 per cent discount to its valuation at the end of last year and, while earnings forecasts will be under pressure, there is a sizeable opportunity for investors with a reasonable time horizon.
A potential surge in M&A activity from international buyers buoyed by weaker sterling and more attractive valuations could provide further support to share prices. However, stock and sector selection will be absolutely crucial. Some mid-cap companies, namely domestic cyclicals, have become cheaper with good reason. We continue to prefer internationally-facing companies and domestic businesses that can weather a slowdown in the economy if required.