Uncertainty surrounding Brexit has continued to cloud the outlook for UK stocks since the 2016 referendum, making it one of the most unloved areas for investors who have pulled money out of domestic equities.
However, Simon Young – manager of the £77.59m AXA Framlington UK Equity Income fund – said that if investors dig deep enough they will find that Brexit uncertainty is creating a number of attractive investment opportunities.
“Often fear creates opportunity,” he said. “There was that initial trade down in the UK equity market, but a lot of companies are continuing to report strong earnings.
“It’s a mistake to confuse the UK equity market with the UK economy. Actually, 70 per cent of FTSE 350 earnings come from outside the UK. So we’ve got a lot of companies that can access structural growth markets.
“But at the same time, you’ve got a number of opportunities out there for companies that are well-positioned [regardless of Brexit] and that’s our job to take advantage of that.”
Young, along with colleagues Chris St John and Dan Harlow have identified at least two trends serving these opportunities: ‘med tech’ within the healthcare sector, and the structural trends in the UK retail market.
Healthcare
The UK – like many other developed economies – is currently in the grip of an ageing demographic trend with the number of people aged 65 or above expected to increase by up to 50 per cent by 2036.
This is likely to put greater stress on pre-existing health services and raise costs as usage increases, which could result in growth in the ‘med tech’ space.
As healthcare companies continue to combine more and more with advancing data and technologies to produce a better patient experience, according to St John.
The manager of the £1.5bn AXA Framlington UK Select Opportunities and the AXA Framlington UK Mid Cap fund highlighted Creo Medical as an example of a company fulfilling this trend.
Held in St John’s multi-cap strategy, the company focuses on surgical endoscopy, specifically making surgery to treat colon cancer less invasive.
Performance of Creo Medical since launch
Source: FE Analytics
St John said the standard of care currently is “pretty horrendous”, but using the company’s devices it reduces patient stress during and post-operation.
“Even in an industry where the demand is growing but the pay-out is under pressure there are some who’ll take their foot off the pedal and some who will do well,” said the manager. “And it’s in their area where medicine and data are all linked together.”
Another example of a growth opportunity in the sector is drugmaker AstraZeneca, said Young.
Performance of AstraZeneca since launch
Source: FE Analytics
“For the first time in 10 years we can talk about them actually growing their sales,” he said. “And it’s growing because they’ve invested in the science and this is a great good news story for the UK.
“AstraZeneca have got a drug now that they will test you and if you have a specific mutation which affects about 15 per cent of women with ovarian cancer, they give you the Lynparza drug.
“That will decrease your time before that cancer starts growing again by 70 per cent, which I think is a fantastic outcome for the patient,” Young said.
UK high street
The second area highlighted by the AXA managers is the UK high street, which has come under increasing pressure from the shift to online.
Dan Harlow manager of the AXA Framlington UK Smaller Cos fund, said that the high street crisis is very real.
“Vacancy rates on the high streets now are at 13 per cent,” he said, “it’s facing tremendous challenges. “Retailers are also being hit by national living wage cost pressures. It’s a kind of perfect storm for many of them and it’s a nightmare for the landlord community.”
Colleague Young said that “Brexit or no Brexit” consumer behaviour is changing.
However, there are some companies – largely in the small-cap space – that are coming to the UK high street and are showing promising long-term growth trends. according to Harlow.
“There are opportunities,” Harlow said, “and that’s kind of exciting for some of the companies that I look at that have unit growth potential and can capitalise on some of the preferential terms that they will be getting from landlords very clearly looking to fill vacancies.”
The first example is the budget-friendly The Gym Group who currently have 160 sites across the UK.
Harlow noted that these types of businesses were previously locked into long-term leases – often at least 10 years – which put pressure on the companies. But this is no longer the case.
The lack of demand for high street properties means that The Gym Group can now enter at lower rates and get a better deal on a shorter contract.
Performance of The Gym Group since launch
Source: FE Analytics
“This gives themselves more flexibility,” Harlow said, “but the best landlords are being more pragmatic, being more flexible about how they’re negotiating with businesses.
“So it’s giving a lease of life to younger dynamic businesses that have a more robust model.”
A final example is furniture giant DFS Furniture, notorious for their seemingly ongoing sales. But their acquisition of furniture retail company Sofology in the past three years has rejuvenated a business that was in a “lacklustre” state, according to Harlow.
Purchasing Sofology means that it has “expanded its market share as some of the weaker competitors go bust”.
DFS Furniture stock price since launch
Source: FE Analytics
“They’re able to go to their landlords and say, ‘right, we want a 50 per cent cut on our rent payments, but we’re going to introduce Sofology and DFS will sit nicely next to that store’.
“So they want 50 per cent less but the landlord has surety that DFS will stay and they get two vacant units filled.”
While disruption and structural headwinds are affecting markets are being felt across all markets But there are still opportunities to be found.
“We’re looking for these companies that are increasing their economic growth,” said St John.
“Compounding that growth which over time translates into increased equity and increased value businesses. That’s what we’re looking for.
“That will happen even without Brexit and general election because you either believe in investing in compounding businesses like we do have in the UK or you don’t.
“Some people will try to market-time but we don’t think that you can market-time, so we don’t do it.”
“The truth of the matter is, markets prefer certainty to uncertainty,” added Young. “So, the paralysis that we’ve had in our political system in the last three years has really meant that investors are nervous about investing in the market.
“But companies don’t stand still, and the good ones they keep increasing their business models and their productive output and we’ve seen some fantastic results in spite of what everyone has told me is a moribund economy in the UK and a difficult global economy."