The UK equity market is filled to the brim with cutting-edge companies and exciting investment opportunities. It has therefore been frustrating to have seen those bright sparks being overshadowed by negative sentiment, firstly on Brexit and then the pandemic.
Finally, however, we are on the cusp of turning a corner, with some of the negative sentiment receding. The market seems to be mirroring my enthusiasm too, with inflows into UK equity funds, rather than outflows, characterising the last few months.
So now with the headwinds of Covid-19 and Brexit lifting, where should investors look to tap into some of these exciting opportunities?
The UK mid-cap market has, over the last 25 years, delivered close to 10 per cent annual returns. That is a similar return to the S&P 500 and compares with around 5 per cent for the FTSE 100.
We believe the opportunity for growth continues to be substantial. In addition to those businesses which have benefitted from the accelerated structural change catalysed by the pandemic, we continue to find numerous attractive investment opportunities in sectors which have been challenged but contain companies that could emerge in a relatively strong competitive position.
Retail
As valuations remain at historically low levels, the UK market continues to look attractive compared to other developed markets. We are particularly enthused by the prospects for stocks that are well positioned to benefit from the pick-up in economic activity following the easing of lockdown restrictions.
One such example is Dunelm, the homewares retailer, which has continued to trade relatively well despite recurring lockdowns. Another retailer we are positive on is Pets at Home, who supply pet products.
Both of these businesses have placed increasing focus on harnessing customer data in order to drive improved retention and loyalty, and they are now reaping the rewards of these investments. This highlights an important theme – companies which effectively utilise the data they generate will enjoy a significant advantage in a world of accelerated channel shift to online retail.
Travel
While retail has produced both winners and losers, one sector that has been hit hard is travel. Despite very difficult trading conditions, some businesses have managed to position themselves well for the recovery and beyond.
One such example is the bus operator National Express, which we believe is likely to be a winner in its category over the long term. This business is highly diversified and has no exposure to UK rail, where many of its peers have previously shed value. It has a track record of strong operational performance, with industry-leading margins and strong cash generation.
Over the last year, while trading has understandably been depressed, National Express has continued to win substantial new business and maintained a robust balance sheet, positioning the company well against peers going into the recovery.
As vaccination rates increase, we expect the eventual easing of travel restrictions to provide a boost for the travel industry. The package holiday provider and tour operator Jet2 is one such business that stands to benefit from the increase in demand from holidaymakers looking to book their holiday ’getaways’. Following significant capacity exit in this industry, the company is likely to benefit from an improved competitive position as we emerge from the pandemic.
Technology
Another key sector that will continue to benefit from the structural changes caused by the pandemic is technology.
The accelerated adoption of online shopping and increased demand for home-working solutions has inevitably created various winners and losers. The move from office to homeworking has elevated demand for products such as cybersecurity software and technology sourcing.
This has benefitted companies such as Softcat, the value-added reseller of software and hardware, and IT sourcing and services business Computacenter. Moreover, changes in corporate behaviour have lowered cost bases – a case in point is Computacenter, which is also profiting from material cost savings.
Industrials
While the consumer resurgence is still in its early stages, the industrial economy has arguably already demonstrated a ‘V-shaped’ recovery, both in the UK and globally. Industrial production has returned close to or in some cases exceeded pre-pandemic levels in the major developed economies and purchasing managers’ index (PMI) data continues to indicate extremely robust momentum.
The implications for a sharp industrial recovery are important for a number of our portfolio companies, including RHI Magnesita and Vesuvius, both of which are geared to the rebounding steel end market, and Marshalls, a building materials supplier benefitting from strong domestic demand.
While there will inevitably be bumps in the road ahead, I remain confident that the rapid vaccine rollout will lead eventually to domestic economic recovery. The UK market, particularly the mid-small cap sector, is home to many exciting opportunities. With the clouds of Brexit and Covid-19 beginning to clear, UK equities are firmly back on the map.
Guy Anderson is co-manager of the Mercantile Investment Trust. The views expressed above are his own and should not be taken as investment advice.