Since the onset of the coronavirus pandemic and the measures to avoid a full-blown health emergency in the UK, investors have become increasingly concerned about any weakness in the small-cap space.
Yet, investors can find many examples there of companies with strong balance sheets, good management and flexible business models that will be able to weather the coronavirus impact as well as any blue-chip company, according to Ninety-One Asset Management’s Matt Evans.
UK equities were badly hit in the early stages of the sell-off as the government was slow to enact lockdown conditions and try to control the spread of the virus.
And smaller companies were particularly affected by the sell-off given their perceived exposure to the domestic economy.
In March, the Numis Smaller Companies Excluding Investment Companies – a commonly used benchmark in the IA UK Smaller Companies sector – fell by 26.33 per cent while the blue-chip FTSE 100 index dropped by just 13.81 per cent.
Performance of indices in March 2020
Source: FE Analytics
“There was extreme stress and it definitely felt as if there were prices in the market that there wasn’t much control over,” said FE fundinfo Alpha Manager Evans. “With little liquidity in the early stages it didn’t feel as if there were forced sellers, but there were people looking for prices.
“Whether it was market makers or machines hitting numbers into illiquid markets, we’re not too sure.”
Evans, who oversees Ninety One Asset Management’s £211.9m Investec UK Smaller Companies fund, said this provided opportunities to add a little to positions in the well-managed companies with strong balance sheets.
Balance sheet strength is one of the manager’s key focuses as he believes this helps to identify those companies with the best sustainable long-term growth prospects.
However, in the current environment it has also identified those that may be better positioned to withstand the worst of the coronavirus downturns.
As such, the manager has been overweight technology and healthcare stocks, areas that have seen increased demand since the onset of the Covid-19 pandemic.
Yet, there have been companies within the portfolio with greater exposure to the UK consumer that have also been able to show how defensive they can be.
Two examples include portfolio holdings Gym Group and Hollywood Bowl, both in the leisure space and both forced to close their doors to their customers.
Performance of stocks over 1mth
Source: FE Analytics
“They were as well-positioned as they could be given this scenario,” he explained. “Given that they’ve managed their balance sheets tightly, they’ve managed to pull back their expenditure in roll-outs [new sites] – which is entirely sensible and will conserve cash.
“But they’re also moving into this period of lockdown having had to shut their stores. In reality, companies like Gym Group will have zero revenue and they’ve also taken the step to cancel their customers’ direct debits realising they can’t offer a service, so they’ll make sure that their customers aren’t out of pocket.”
Companies with strong financials have also been able to look after their staff during the lockdown period, with Evans – who also manages the £24.9m Investec UK Sustainable Equity fund – having been “quite encouraged” by some of the stories that he had heard about from investee companies in how they have looked after staff during the outbreak.
Hollywood Bowl – a top-five holding representing 3.1 per cent holding of the portfolio as at end-February – came into the crisis with a net cash balance sheet closed before the government ordered a lockdown, “believing it the best thing for their people and their business”.
“These are businesses once they are up-and-running will be well-positioned to keep operating,” he explained. “The difficulty is how quickly consumers can come back into these areas and is therefore very hard to forecast.
“We have to ensure that these businesses give themselves the best chance to be operating as efficiently as possible once people come back and having strong balance sheets is a critical part of that.”
The focus on balance sheet strength has been successful in helping to identify those companies that may emerge from the lockdown conditions with minimal impact.
“We’re clearly looking at the balance sheets and ensuring they can survive and hunker down in difficult times but position themselves for the medium-to-longer term,” said the Investec UK Smaller Companies manager. “Understanding the short term financial and balance sheet risk is really key, but so is understanding how these businesses will be able to position themselves well for the future.”
Since Evans joined Investec UK Smaller Companies in November 2017 after leaving Threadneedle Investments, where he managed several portfolios, it has made a loss of 7.86 per cent – in total return terms – through 21 April, compared with a loss of 14.25 per cent for the average IA UK Smaller Companies peer and a 24.44 per cent fall in the Numis Smaller Companies plus AIM (excluding investment companies) benchmark.
Performance of fund vs sector & benchmark under Evans
Source: FE Analytics
The fund has an ongoing charges figure (OCF) of 0.82 per cent.