Despite Brexit, the UK small-cap sector has a number of interesting international-facing stocks, according to Standard Life Investments European Smaller Companies manager Andrew Paisley. 
The fund, which has been the fifth best performer in the IA European Smaller Companies sector over the last five years, has 33.2 per cent of its assets in the UK, a slight overweight compared to the FTSE Developed European Small Cap Index’s 31.9 per cent weighting.
“The overall weighting to the UK is actually marginally overweight at the moment with quite a big rotation from domestic to international names,” Paisley said.
The manager uses Standard Life Investments’ bespoke ‘Matrix’ quantitative screening process looking at a number of key factors and he said that many of the new ideas being brought through this system are UK exporters.
“Matrix scores within domestic names are falling to negative territory but conversely some really quite scores are coming through in some of the exporters,” he said.
“These Matrix scores have really risen quite considerably over the last 12 months and it is probably the biggest change to the portfolio post Brexit - rotating from domestically facing names to exporters.”
Below, FE Trustnet looks at the three UK stocks that Paisley says the market has mispriced and have come through the screening process.
The first is company turnaround specialist Melrose Industries PLC, which buys manufacturing businesses with the potential for improvement.
“Melrose is a relatively recent addition –within the last 12 months – which is quoted in the UK but almost entirely does business in North America,” Paisley said.
The £4.7bn company had a strong run in 2016, rising 263.81 per cent after it announced a rights issue and the subsequent £2.2bn acquisition of American home ventilation equipment maker Nortek at the end of August.
Performance of stock in 2016
Source: FE Analytics
“It’s a tried and tested management team that have been together for a long time now,” Paisley said.
“What they do is buy, improve and sell – that’s the strapline and they made a big acquisition back in 2016 of a US business called Nortek.”
The manager said that this type of acquisition is typical of what Melrose is trying to do – buy good quality businesses and turn them into great businesses.
“In the case of Nortek, this was a business that was generating an operating margin of 10 per cent – so perfectly respectable – but they’ve already been able to move that up to 15 per cent,” he noted.
“We still think there is more to go for there and also in the top line where the market has been too conservative.”
Paisley added: “This has gone so well however and gone up a lot more quickly than expected that we’re probably expecting to see them do another deal in the next 12 months. So it will be more of that again I would expect.”
The second company he has bought recently is the £1.2bn Diploma PLC, which he described as a “value-added distributor”.
The firm, which supplies technical products and services such as heavy machinery parts, is a member of the FTSE 250 with much of its earnings derived from North America and Europe.
Much like Melrose, the firm had a strong 2016, returning 39.71 per cent over the year, and has been on a steady rise upwards over the last decade, up 739.52 per cent.
Performance of stock over 10yrs
Source: FE Analytics
“What we think the market has got wrong here is the margin potential within the business,” Paisley said.
“It’s a high quality business with margins around the high teens – 18 per cent – a good track record of growth that we believe will continue with momentum.”
The firm is aimed at three core markets – life sciences, seals and controls – and Paisley noted that it is trying to buy and build its range in all three markets.
He added that the “Matrix support is very encouraging and we think is a long-term winner” with both himself and Standard Life Investments UK Smaller Companies fund manager Harry Nimmo owning the company in their respective funds.
Paisley added that both Bruce Thompson and Nigel Lingwood, the chief executive and the finance director, have been at Diploma for a long time and are “extremely well respected”.
The third company he has bought recently is the £2.4bn Intermediate Capital Group, which is a specialist asset management company aiming at non-listed companies.
“It’s the leading player in the private market space and what we’re seeing here is a change in the business away from investing off their own balance sheet and becoming more of a third party asset manager,” Paisley said.
This should lead to higher quality earnings and a higher dividend potential for investors as the assets under management increases, the manager said.
Additionally, he said that there is growing structural demand for un-listed company information and exposure.
“The structural growth story here is around increased asset allocation to private markets generally and I think that in-house we are doing that more as well,” the manager noted.
Over the last three years the company has risen 208.45 per cent and the manager said the growth story could go on for much longer – something the market is not yet pricing in.
Performance of stock over 3yrs
Source: FE Analytics
“We think that will continue as investors look for uncorrelated returns,” he said, adding that the firm is now one of the market leaders in European private markets.
“We believe that they will be able to grow faster than the market is expecting in terms of assets under management and also will benefit that transition in the business away from managing off their own balance sheet to managing for whoever wants to give them money.”