There is no doubt that Brexit is having an impact on UK businesses – but not on those large enough to be listed on the stock market, according to Jonathan Brown, manager of the Invesco Perpetual UK Smaller Companies trust.
The UK has underperformed its global peers since it voted to leave the EU in July 2016, as international investors have shunned the domestic market – Brown’s co-manager Robin West referred to it as an “orphan asset class”.
Many UK fund managers have claimed that once the final Brexit deal was reached, this greater certainty on the direction of the UK would lead to the return of international investors, helping the FTSE All Share close the gap with other major markets.
Yet it has almost been a year since the transition period between the UK and the EU came to an end, and the FTSE is still one of the few major global markets that looks cheap.
Source: Invesco
When asked if the UK could remain on its current low rating for the foreseeable future, Brown said: “It’s possible, but it seems unlikely to us. Optically, the UK hasn't looked great through the Covid crisis and when you get people queuing up for petrol stations, it's not a good look for international investors.
“But private equity investors really see value in the UK and that's why we've seen so many takeovers. Even if it's not recognised by institutional fund managers, it has been recognised by other buyers in the market and over time that will lead to a rerating.”
Brown accepted the departure from the EU has not been the clean break many had hoped for. He said it had been particularly hard for the smallest businesses that export to the continent, saying “if you're a 20-person business having to deal with that amount of red tape, that's a significant problem”.
Yet although he buys small companies, he said those large enough to be listed haven’t experienced major problems – and the worst now appears to be over.
“The businesses we have spoken to were building up inventory ahead of the start of this year just in case there was significant disruption, and that seems to have tided them over well,” he continued.
“What we're hearing is that the initial chaos – in terms of all the extra paperwork and delays and red tape – is starting to resolve itself. For example, software is being written to take care of the paperwork and larger businesses in particular have managed to cope pretty well with it.
“Companies are having to carry a little more inventory because it takes longer to get goods between the UK and Europe, and in some cases build warehouses on the continent to ensure they can fulfil customer orders quickly. But beyond that, it feels like it's settled down.”
This is starting to feed through to business confidence, with the manager noticing companies are now more willing to invest for expansion or spend money on acquisitions, following an extended lull after 2016.
“They didn't want to take a risk in case there was a hard Brexit,” he added. “But now we're seeing companies start to push the button on things like that, and that should be supportive for the UK economy over the next two or three years.”
There are further problems for export businesses that have nothing to do with Brexit. Brown said there has been a major increase in shipping prices, with “the cost of getting a container load of goods from China to the UK up between 10 and 15 fold over the past year”.
Further issues with supply chains and reduced inventories have been compounded by a sudden surge in demand as economies have re-opened, forcing up prices. While Brown said these problems should dissipate as we move through next year, he is worried their psychological impact could prove more difficult to resolve.
“I guess the question really is around wage inflation and whether we end up in an inflationary spiral,” he added.
“We don't have a strong view on that. We're certainly seeing wages increase, not just in the UK, but in a range of other countries. Our best guess is that inflation remains high over the next few months, but starts to abate as we move through 2022. But it could remain higher than we've seen for the last decade or so due to high wage inflation.”
However, he said that most of the businesses in his portfolio have pricing power – either as a result of unique products or dominant market share – allowing them to pass on higher costs to their customers.
He accepted that some businesses may have to take a hit to margins in the short term as contractual arrangements have led to a delay in passing on prices, but again expected this to resolve itself by next year.
Overall, he was in bullish mood on the UK, “both because of consumer balance sheets being stronger now than they've been for a number of years, and also the improvements we're seeing in business confidence and business capital expenditure”.
“Wage inflation as well is putting a bit more money into consumers’ pockets. So we think things are pretty solid,” he finished.
Data from FE Analytics shows Invesco Perpetual UK Smaller Companies has made 391.1% over the past decade, compared with gains of 334.9% from the IT UK Smaller Companies sector and 224.8% from the Numis Smaller Companies ex ITs index.
Performance of trust vs sector and index over 10yrs
Source: FE Analytics
The trust is on a discount of 10.5%, compared with 10.7% and 7.9% from its one- and three-year averages. It has ongoing charges of 0.91% and yields 4%, a figure that is rebased to the year-end share price.