A Conversation with Richard Penny
This month, we had the pleasure of speaking with Richard Penny, Fund Manager at Crux Asset Management to discuss the outlook for UK small-cap stocks.
Current Market: What’s happening in the UK? The small cap market in the UK has had a third year of underperformance, diverging from the typical two-year slump (refer to the slide below for context). Large life funds and pension funds have been de-emphasizing the UK and disinvesting from illiquid assets. Many have set a £500m market cap as a threshold and are selectively selling holdings below this. This is concerning, as historically such long-term funds have been buyers during market sell-offs.
Open-ended savings products, such as OEICs and unit trusts, have faced persistent redemptions in the UK for 35 months in a row. This has impacted UK small cap funds, with multiple funds selling at once and few buyers. The low point came in January and February when 23 trading updates reflected worsening conditions. However, we have subsequently seen significant levels of incoming small cap M&A. This returns capital to fund managers and enhances returns, meaning fund managers have less money going out and more cash on account; therefore, they don’t need to sell assets.
Market Volatility: What's the most important takeaway for micro and small caps? The volatility is short term and therefore unlikely to lead to widespread redemptions. We hear July saw the best month for UK flows (very small outflow and some inflows for selective fund managers). If volatility leads to widespread redemptions, then it will have an effect.
Wealth managers who buy funds have been moving more global over the long term, but when rates were at 5%, they were charging 1.3% to clients who can get 5% in the bank. The UK is very cheap and should give double digit returns from here, but performance has been poor since the 2016 Brexit decision. Making easy returns in Nvidia and AI feels good and beats cash in the bank even if the shares are not cheap.
New Government: What impact(s) will the new government have on the UK and global markets? The new Government could potentially bring some return of political stability - the previous one was simply unable to legislate. A big majority and an initially not-too-scary centrist Labour government feels acceptable. The UK is at a 30-year low versus the rest of the world, and the alternatives are not great. Issues in Europe (far-right and anti-Europe sentiment), potential conflicts in Asia, volatility in Japan, and volatility in major AI stocks serve to remind portfolio managers of the concentration in their holdings. The UK has derated since the 2016 Brexit referendum when compared to global equities.
Financial Conduct Authority (FCA): Who benefits from the newly finalized rules to unwind 2018’s MiFID II and what impact will it have on the markets going forward? The impact likely won’t be immensely consequential, but there will be some positive effects. Previously, we weren't allowed to receive research unless we paid for it, including corporate stocks. Although not independent research, (we shouldn’t need to pay for it), it is difficult to accept this research. The decision may make stocks marginally more liquid.
