Market Commentary- UK Small Cap Team, January 2022

16 February 2022

By Scott McKenzie

After a positive end to 2021 global markets began the new year in panic mode, with most major indices coming under pressure as investors faced up to the realisation that we have reached the end of a long era of loose monetary policy. As a result, we saw dramatic reversals in highly priced growth stocks, led by a stark decline in the NASDAQ index. Whilst most large tech businesses continued to produce robust results a number of bubbles began to burst with US bull market icons such as the ARK Innovation ETF and Netflix, as well as Bitcoin, coming crashing down to earth. Early-stage investments in areas from technology to healthcare and new energy bore the scars of a rapid decline in investor bullishness.

As the threat from the Omicron variant was downgraded globally, for once the pandemic took a back seat, with the main new geopolitical drama being the potential for conflict in Ukraine. This reignited ongoing concerns about energy security and gas prices across Europe and could lead to a further squeeze on consumers.

Despite a meaningful end month rally the S&P index fell by 5.3% and the NASDAQ by 9.0%. For once the Numis Large Cap was a safe haven and actually rose by 0.8%, reflecting its low tech weighting and high exposure to banks, tobacco and oils. Smaller UK indices fared less well however with the Numis Mid Cap down 7.4% and Numis Alternative Markets –9.8%. We saw large rises in government bond yields, with the US and UK markets leading the charge given their more imminent monetary tightening cycles and rapid increases in shorter term inflation, at 7.0% and 5.4% respectively. After a particularly eventful Fed meeting in mid-January, it has now become clear that a number of US rate increases could be possible during 2022 and the Bank of England is also now in similar tightening mode.

All of this added up to dramatic changes of market leadership everywhere and, in terms of style factors, value significantly outperformed growth and momentum during the month, as investor sentiment swung rapidly. However, in many ways the events of the month can be viewed as a reset of valuations and risk appetites rather than a dramatic reappraisal or deterioration of economic prospects.

On a more positive note UK equities remain modestly priced in an international context and we now see opportunities to increase our holdings in high quality companies with strong balance sheets at more attractive valuations. This is what we have done as the month progressed.

TB Amati UK Smaller Companies Fund

The TB Amati Smaller Companies Fund fell by 8.7% over the month, behind the benchmark return of -6.4%. Our bias towards growth stocks was tested in a market where value styles outperformed and monetary tightening dominated investor sentiment.

In a difficult market our positive contributors were resources stocks, as oil prices continued to rise to a seven year high. Petrotal, Energean, Jadestone and i3 Energy all yielded positive returns. The highlight for the Fund was Air Partner which received a cash takeover bid at 125p per share, a 40% premium to the prior value.

Given the broad market selloff several of our highflyers from 2021 fell sharply. These included ATG, Accesso, Ergomed and Molten Ventures - whilst Renalytix continued to suffer as early-stage growth stocks were shunned. Holdings with equity market sensitivity were hit hard, including Liontrust and Polar Capital. Consumer exposed sectors came under pressure thanks to interest rate concerns with our holding in housebuilder Vistry impacted. Punitive tax threats around cladding costs from Michael Gove also added to the sector malaise here. We also endured two stock specific disappointments. Cake Box fell by 33% in response to concerns over accounting presentation after several years of significant growth. Of greater concern was Sensyne, which declined sharply after failing to find a buyer for the business and which faces an uncertain future in terms of its funding structure and revenue generation. We have now sold our holding.

In the light of the ongoing increases in inflation and interest rate expectations we continued to reduce portfolio risk and exited several holdings where we felt the risk-reward balance was no longer favourable or where the position sizes were sub-scale. Sales included Genus and AB Dynamics, both of which are high quality businesses which we have held for some time. However, in both cases their high valuations are no longer supported by positive earnings upgrades, leaving them vulnerable to earnings disappointment and de-rating. Other sales were of small holdings in businesses which have recently seen earnings setbacks and weak share prices.

We added emergency repair specialist Homeserve. We’ve followed this business for some time and the shares have seen a material derating, mainly related to the maturity in its UK policy book. This has detracted from the strong progress made in North America, which is now the largest source of group profit.

Amati AIM VCT 

The Amati AIM VCT fell by 8.1% in January, slightly ahead of the Numis Alternative Markets benchmark , which fell by 9.6%. It was a testing market for smaller companies in general, especially in earlier stage businesses which make up most of the portfolio.

Despite this difficult background we were able to report some positive contributors for January. The key highlight was the ongoing strong performance from technology training business Northcoders, which rose by 32%, building on an excellent run since last year’s IPO. Our large position in drug developer Polarean was another bright spot with the shares rising by 5%.

Given the broad market weakness a number of our holdings were subject to price weakness as early-stage growth stocks were shunned and highly rated growth companies repriced downwards. In the gaming sector Keyword Studios and Frontier Developments fell sharply as did software businesses GB Group, Learning Technologies and Craneware. In healthcare Maxcyte and Rua Life Sciences were caught in the crossfire of early-stage company selloffs whilst Water Intelligence gave up some of the significant gains seen in 2021. We made no new qualifying investments during the month, although the pipeline of deals remains significant.