Brexit has caused a higher level uncertainty in the mid-cap space, according to Guy Anderson, co-manager of The Mercantile Investment Trust. 
From the middle of 2014 through to the EU referendum, Anderson had been positive on the outlook for UK consumers with improving employment trends and improving wage growth set against declining cost of living, he is now cautious on the UK economy and has repositioned is portfolio accordingly.
Mid-caps were among the hardest hit following the EU referendum, with many fleeing riskier assets for the more defensive large cap companies.
As the graph below shows, the FTSE 250 – which has a high proportion of domestically facing companies –was hit a lot harder than the internationally-facing FTSE 100 as the pound plummeted against the dollar, falling 12.24 per cent in the days following the vote.
Performance of indices since the EU referendum
Source: FE Analytics
“Where we are today though there is clearly a higher level of uncertainty than there was for us particularly before the [Brexit] vote because clearly we’ve got increased levels of economic uncertainty,” Anderson (pictured) said.
“That combines with the fact that sterling has depreciated quite materially versus the US dollar and the Euro in particular as, whilst this has no immediate impact for the majority of consumers, ultimately it will feed through into increased cost of living when we look forward into 2017 and beyond.”
What that has meant is he has had to reposition the portfolio away from companies where the main investment thesis was of a positive domestic macro environment.
“We haven’t moved the portfolio into being defensively positioned because we think that the UK is suddenly going to find the economy unravelling, it’s just reflecting that greater uncertainty,” he said.
“We’re focusing on companies that are generating their growth more by structural or internal actions than ones that are probably more mature and driving their growth based on the environment that they find themselves in.”
With this in mind, Anderson outlines the sectors (and stocks examples within them) that he has bought or sold as a result of this changing economic outlook.
Housebuilders
Anderson has been positive on housebuilders for many years, initially investing more than five years ago, but has recently been selling some positions to reduce it to a “normal” weighting in his portfolio.
Anderson said: “We’re still positive on the longer term outlooks in terms of supply and demand and some of the structural changes to the housebuilders in terms of the industry.”
Before the referendum, all signs pointed up, with “the big push from the government and the much greater availability of land keeping land prices down,” he added.
“Not having to absorb that land price inflation gave them greater certainty over the outlook for returns and the businesses were clearly operating at high levels of profitability.”
However, the sector was rocked by the Brexit vote, as the below graph shows, with housebuilders tumbling 14.41 per cent in the immediate aftermath.
Performance of index since the EU referendum
Source: FE Analytics
Despite this fall, Anderson sees upside in the sector.
“What we’ve seen since the referendum is we haven’t yet seen any real change in consumer behaviour in terms of when they look at reservation rates and customer enquiry levels – those have really held up quite well and that did surprise us positively,” he said.
“What we’ve done is focus on a couple of the companies that we think are best placed at this point in the housebuilding cycle - though we do think we are relatively later stage in that cycle.”
He suggests Bellway, Berkeley Group and Taylor Wimpey as three companies worth investing in, as they are “very good at managing the cycle in terms of when they invest in land and when they run the business more for cash and return that to shareholders”.
Consumer Discretionary
The sector has been a large part of Anderson’s portfolio for the last two years, with consumer services constituting 28 per cent of The Mercantile Investment Trust portfolio.
However, Anderson says that it is a sector that he is “incrementally less positive on now” given the shifting economic and consumer backdrop.
He says he has exited companies that rely more on consumers feeling wealthier, with the likes of sofa maker DFS and bakery Greggs as two examples where consumers may not buy as much in the current climate.
“Greggs could be an example of where we had a very successful investment but where we always thought it was because of the maturity of the business and that was something that we thought was more driven by the health of the consumer,” he said.
He added that the companies he’s focusing on now are businesses like Domino’s Pizza, which has been generated double digit like-for-like growth for the last two years due to actions taken to stimulate demand.
“They clearly have been investing quite significantly in marketing but also in their IT platform and so this is a business that I think has generated consistently high growth and will continue to even in the event that the consumer doesn’t feel quite as wealthy as they have done in the past,” he said.
Mining (Gold)
While not in love with sector on the whole, Anderson says he has upped his exposure to gold in recent months with the acquisition of Polymetal International.
“We like the fact that it has low cost assets so it isn’t a marginal producer of gold [meaning] it is better able than some to withstand any volatility that we might see in the price of gold,” he said.
“And because of its position on the cost curve it should be consistently profitable generating good cash flows and its undergoing quite a significant increase in production over the next four years.”
“Its track record of meeting and beating expectations is strong as well as it has quite a clear focus on shareholder returns.”
Gold has been on an upwards trajectory this year as investors have fled risk in search of the more traditional ‘safe havens’.
Performance of indices in 2016
Source: FE Analytics
Having plummeted over the last few years, gold has rallied 41.49 per cent so far this year on the back of concerns over a slowdown in China, the Brexit vote and the Federal Reserve’s unwillingness to raise interest rates, among the key factors.
Oil & Gas
Also included in the above graph is the oil price, which has rebounded from January lows to rise 40 per cent this year.
This is still some way-off the all-time high prices seen in 2012, and Anderson says despite owning small holdings in some oil producers, that he is cautious on the sector.
“Oil and gas has been largely absent from the portfolio now for nearly two years. We do have a couple of small holdings - so it’s not that it’s a sector that we don’t touch - but on aggregate we’re relatively cautious on the outlook for the price of crude given how well supply has held up over the last couple of years and demand growth, while it has been consistent it has been relatively low,” he said.
“Given the changes that the oil and gas producers have managed to undertake in terms cutting costs, the breakeven price has dropped so significantly over the last two years that actually there’s a lot of capacity that can come on stream if the price of crude increases just a small amount.”
If this were to happen, by definition, the price would fall back again, and Anderson adds that this “makes the oil price somewhat more range bound over the coming months”.
Overall he says “for us that’s not a hugely appealing sector for us at this point in time.”