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Earlier this month, when asked by Sky News to comment on how Brexit uncertainty had conspired to drive down the UK stock market that day, Lord Lamont’s argument that it had nothing to do with Brexit and much more to do with worsening economic expectations in the US was met with evident scepticism on the part of the programme’s presenter1.
However, the former Chancellor happened, on that day, to be right. On many other days he may have been right also, not least because the link between the UK stock market and the UK economy has become increasingly tenuous over recent years.
According to research conducted by FTSE Russell last year, around 76% of all the sales made by the UK’s 100 largest listed companies between 2007 and 2015 were overseas2.
This result makes intuitive sense, because businesses successful enough to become big in the UK will have, at some points in their history, sought to repeat that success in other territories. Such expansions may have come about through organic growth, or via foreign acquisitions.
Recent examples of the genre are the long established plumbing and building products group Wolseley – these days called Ferguson – and the insurer and asset manager Prudential. Both were ejected from the UK-focused FT 30 Index earlier this year, for turning into companies with predominantly non-British sales3.
These days, we think of Britain’s largest companies as those that make up the FTSE 100 Index. This index was formed in 1984, starting out at a level of 1000, and was designed to supersede the long running FT 30 or, as it was known back then, the FT Ordinary Share Index.
The FTSE 100 differed from its predecessor by including more than three times as many companies and by weighting them according to their market values. The FT 30, on the other hand, did then and continues to be essentially a geometric average of the share prices of its constituents4.
If you think that’s archaic, then you might want to consider that the Dow Jones Industrials Average in the US – perhaps the world’s most recognised market – is also still calculated in much the same way.
After the FTSE 100 comes the FTSE 250 Index – the next largest 250 UK companies. This is often understood to be an index that more closely tracks the UK economy. However, this is now less true than it once was.
The FTSE Russell research shows that, if you exclude the investment trust companies listed on the FTSE 250, 51% of the sales made by its constituent companies are overseas. That’s considerably more even than Japanese companies, which derive just 32% of their sales from overseas customers5. So the FTSE 250 is, in fact, now as much a window on the world as it is the UK economy.
This factor, as much as any other, helps to explain the day-to-day and even month-to-month dislocations we see between the UK’s economy and its stock market. A worsening outlook for the UK economy tends to lead to a weaker pound which, in turn, raises expectations for the amounts UK companies will earn overseas. Equally, the reverse is true, so positive news on the economy can actually lead to the UK market falling.
The LF Lindsell Train UK Equity Fund, a long-time favourite on Fidelity’s Select 50 list, clearly has a penchant for “companies from here doing rather well over there”, to paraphrase Hanson’s famous 1980s slogan.
Its top-ten holdings list is dominated by UK multinationals, from beverages and consumer products groups like Diageo and Unilever to the global information provider RELX and accounting software specialist Sage Group.
Finally, no discussion of the UK market can be complete without a look at smaller companies.
Current advocates of smaller companies – those too small to fit the FTSE All Share Index – can argue some distinct advantages. Being less mature, smaller companies tend to grow faster, yet there has been a trend among some over recent years to pay early dividends too.
However, investors may also need to be patient because smaller companies can experience rocky periods, especially when investor sentiment turns down and the smart money flees to large stocks with the highest perceived levels of safety.
The current iteration of the smaller companies market most investors look to is AIM – the Alternative Investment Market. Its equivalent back in the early days of the FTSE 100 was the Third Market, which closed in 19906.
Like its forebear, AIM demands less of its constituent companies in terms of entry criteria and reporting standards. It can also expose investors to quite immature markets – via oil & gas or mining companies, for instance, with operations concentrated in esoteric and far-flung jurisdictions.
However, another aspect of AIM is that an increasingly wide geographic footprint means that judicious stock selection can be used to gain some significant diversification benefits. At its launch in 1995, the index contained no international companies at all. Today, 141 of its 926 constituents fit the description7.
Pick the winners and the rewards can be immense. At the end of last month, 12 AIM companies were worth more than £1 billion each, with a handful – including ASOS, Burford Capital and Fevertree Drinks – worth considerably more8.
However, not all of this market’s members are bound for great things – a good number do not survive the pressures bearing down on early stage or even more mature businesses, resulting in fast and, too numerously, total losses for investors.
That’s just another reason to embrace the idea of diversification, so that almost inevitable losses in one part of a portfolio of smaller stocks can potentially be won back in another part.
The furthest down the company size spectrum Fidelity’s Select 50 list currently goes is the FTSE 250 Index, with a listing for the highly respected Threadneedle UK Mid 250 Fund. You’ll find smaller companies occupying positions in other Select 50 funds, but they’ll be in the minority.
The Threadneedle Fund is billed as targeting the “Goldilocks part of the UK market” – not too big or small but just right. The manager James Thorne targets companies with sustainable growth, where forecasts and market ratings fail to appreciate the potential.
The current portfolio, which consists of just 39 stocks, is skewed towards industrials, consumer goods and technology companies primarily at the expense of financials. Britvic, the emergency plumbing business HomeServe and SSP Group, which operates catering and retail units at airports and railway stations, are the top holdings9.
1 The Express, 07.12.18
2,5 FTSE Russell, May 2017
3 FT, 24.04.18
4 FT.com, 29.06.06; The Financial System Today, Rowley, 1987
6 GOV.UK, December 2018
7,8 London Stock Exchange, 04.12.18
9 Colombia Threadneedle, 30.11.18
The value of investments and the income from them can go down as well as up, so you may get back less than you invest. Select 50 is not a personal recommendation to buy or sell a fund. Reference to specific securities should not be construed as a recommendation to buy or sell these securities and is included for the purposes of illustration only. This information is not a personal recommendation for any particular investment. If you are unsure about the suitability of an investment you should speak to an authorised financial adviser.