In a recent GBI special episode of IFA Talk, Fraser Mackersie, Fund Manager at Unicorn Asset Management, joined us to reveal what makes UK small and mid-cap companies an attractive investment opportunity. He also shared how Unicorn’s approach focuses on the fundamentals, and why that can be especially powerful in this part of the market.
Unicorn are specialists in the UK small and mid-cap area of the market, with a long history of generating strong returns.
An attractive investment opportunity
UK small and mid-cap companies are capable of growing significantly over time, generating very strong returns, but Fraser believes that the market has been overlooked for some time. “They’re generating strong profits and paying good dividends, he stated. “The area has been overlooked on a global scale for some time, resulted in some really interesting valuation opportunities, whether you’re investing for growth, smaller companies, income, or looking at tax products.”
Focusing on fundamentals over the long term
While many view small and mid-caps as a very high risk area of the market, Fraser stressed that Unicorn’s method of focusing on the fundamentals has alleviated a lot of concerns. “We look to invest in companies who have proven their business model and their capabilities in terms of profitability and cash generation”, he explained. “They’re supported by a strong balance sheet to fund future growth and provide resilience when times get a little bit tougher.”
Another key focus for Unicorn is understanding the people involved in running each business. “It’s quite a labour-intensive job at the lower end of the market cap scale because you spend a lot of time meeting management teams,” Fraser explained. “While business can look great on paper, you need to understand the people running it, what drives them and what their plans are.”
Fraser stressed the importance of consistency of delivery, explaining that it helps investors to build confidence. Fraser added, “This is all about reducing the level of risk as much as possible, while still benefiting from the upside that we’ve talked about that’s available in small and medium-sized companies.”
The effects of War, Brexit and COVID
The world has faced turbulent times over the last decade in all areas, including the world of UK smaller mid-caps. A key period was the Brexit vote and its subsequent fallout. “Regardless of your views on the Brexit vote, it changed the way people look at UK equities,” Fraser explained. “It kicked off a period of political uncertainty, which is never good for equities in general, and especially so for smaller mid-caps, which are seen to be more exposed to the domestic economy.”
Fraser also noted that the changes in leadership in the UK have also taken their toll on the market, although he spoke positively about his outlook for the future. “We’re at a point now where the situation has started to settle down,” he reassured. “Regardless of your political allegiances, we now have a government in place with a mandate to govern, so hopefully the period of uncertainty for the time being is over.”
Along with Brexit, the global pandemic in 2020 also greatly altered the way businesses were run. “COVID came along and knocked quite a few businesses for six,” Fraser noted. “Some performed well because of the business model, while others found it extremely challenging.”
Meanwhile, the Ukraine and Russia conflict has also had an effect, with Fraser highlighting that it has impacted commodity prices, which he said aren’t typically well-represented in the small and mid-cap space.
An interesting time for UK smaller mid-caps
Fraser pointed out that research and analyst coverage in the small and mid-cap space has reduced over recent years in the UK, but this has not been an issue for Unicorn. “We do all our research in-house and don’t particularly rely on analyst input,” he revealed. “We engage with the analyst community, because there are some really skilled analysts in that space.”
He added that now is an interesting time to look at the smaller mid-cap space, stating, “A lot of the points that I’ve talked about have certainly started to subside, creating a much more supportive environment for smaller mid-caps.”
Driving interest and performance
Fraser revealed that, while there isn’t a definitive right answer, there are a few factors that will create a much more supportive environment for UK smaller mid-caps. This comes after a time where businesses were seemingly investing more outside of the UK, often neglecting domestic opportunities.
“I think we will see an increase in the flows to domestic funds,” he said. “Interest rates are coming down, probably not as fast as anyone in our area would like, but they are coming down, and that is supportive for UK equities and smaller mid-caps in particular.”
He also spoke positively about the UK’s trade position, especially in terms of recent trade deals with the US. “When you look globally, we were the first to sign a deal with the US,” he noted. “We seem to be working a little bit closer with Europe, so I don’t think we’re in a bad position trade-wise at all.”
Looking ahead, political stability can only be a positive
Within the UK, Fraser believed that the political backdrop has stabilised to some extent recently. “We don’t think the government’s had a great start for a pro-growth government, but they are in power for a while, and we shouldn’t have this chopping and changing of power at the top anymore.”
Fraser concluded by outlining his hopes for the government as their tenure progresses, focusing on improved industrial strategy and their infrastructure plans. “All of that will clearly help UK domestic companies and small mid-caps,” he stated.
