Three Brexit-proof small-cap stocks

Can global small-caps help investors navigate the current turbulence? Nimble and more adaptive in difficult markets, Trevor Gurwich explains why investors shouldn’t overlook them.

The UK’s forthcoming departure from the European Union has placed one of Europe’s largest economies under a cloud of uncertainty since the June 2016 referendum. This uncertainty has claimed more than one British prime minister’s job.

Most recently, Teresa May’s failure to forge a deal that both the EU and her colleagues in Parliament could live with led to her resignation. The UK is expected to leave the EU on 31 October, but it’s anyone’s guess how and when the Brexit situation will be resolved.

We believe that investors can navigate the ongoing uncertainty by diversifying their portfolios into global small-cap companies. As the exit scenario remains unclear, the market will likely differentiate between stocks based on fundamentals.

We think that small caps can be nimbler and more adaptive in difficult markets, such that an active small-cap manager may be able to identify companies positioned to succeed despite the uncertain environment.

Additionally, the global small-cap universe contains significantly more stocks than the large-cap universe. Thus, investors have many more choices in seeking companies with potential to succeed, regardless of short-term economic conditions.

With a global approach, when one region is pressured, another region is usually thriving. The size of the global small-cap market allows investors greater flexibility in selecting companies with less exposure to negative conditions.

Small-cap companies tend to be more domestically focused than large-cap companies. At first, this might seem to suggest that large, globally focused names domiciled in the UK would be less exposed to political complications such as Brexit compared with small, domestically facing companies.

We believe this to be true to an extent, but we’re currently finding opportunities in several small-cap companies that derive the bulk of their revenues from outside the UK.

Thus, the ongoing Brexit uncertainty and its attendant pressure on the British pound has less impact on these companies. It’s worth noting, however, that opportunities remain among domestic companies with solid balance sheets and effective business plans, despite the pressure that Brexit is placing on the UK economy.

Aveva Group is one example of a UK-domiciled business with a global focus. This global leader in industrial software derives approximately 96% of its revenue from outside the UK. Its recent combination with Schneider Electric Software helped provide a wider geographic reach, including greater exposure to North America, and a broader suite of products for its clients.

The firm is benefiting from the digital transformation of industry, a secular trend that helps insulate Aveva from the domestic issues and political uncertainty related to Brexit. We believe the company has scope to deliver both faster revenue growth and higher profitability.

Another globally focused name is Keywords Studios. The UK-listed company (headquartered in Dublin) outsources technical services to the video gaming industry. The firm is benefiting from two secular trends within gaming - the accelerated development of streaming games and increased outsourcing of non-core game creation services, such as translation, localisation, testing and art creation.

With direct exposure to the globalisation of gaming, Keywords Studios is more closely aligned to growth in the global gaming industry and less exposed to the UK’s domestic economic conditions.

Finally, we’ve identified domestically oriented businesses in the UK that are benefiting from secular trends and Brexit-related economic uncertainty.

An example is Moneysupermarket.com, a leading price comparison website. The company is attracting increasingly price-sensitive UK consumers by allowing them to save on a wide range of services, including insurance, energy, and credit cards.

We also believe the company’s significant investment in its new technology platform will help deliver accelerated revenue growth. Its new information technology platform no longer relies on multiple databases, but instead is based on a single cloud-based platform that allows the company to optimise search activity, deliver proactive customer recommendations, and offer an improved mobile customer experience.

Alongside an expanded product offering, we believe that the company’s tech investments should support a sustainable acceleration in earnings growth.

Trevor Gurwich is senior portfolio manager at American Century Investments.

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