Ignore Brexit Noise Says Top Manager Betting on Small Caps

(Bloomberg) -- The U.K.'s divorce negotiations with the European Union will be less of a driver for equity markets in 2017 and that should benefit investors in smaller businesses, according to one of Britain's best stock pickers this year.

Sterling's decline, which boosted firms with overseas earnings, is unlikely to be replicated, said Richard Penny, a London-based senior fund manager who oversees about 750 million pounds ($932 million) at Legal & General Investment Management, making stock picking more important. He's counting on small companies in software, electronics and advertising to keep him among the top stock pickers this year.

“Could sterling weaken further? It could, but we think we have seen the majority of the move there,” Penny said. “The market should become less macro-economic driven and more stock-picking driven, which is what we benefited from since the start of the year.” Penny's U.K. Alpha Trust has returned 8.4 percent so far in 2017 compared with 2.7 percent, including reinvested dividends, for the FTSE All-Share Index, beating 98 percent of its peers.

U.K. Prime Minister Theresa May plans to trigger the formal Brexit process by the end of next month, leading to concerns that the Brexit negotiations will hurt some British company's earnings by increasing sourcing costs because of the weaker pound. The vote dominated markets last year as investors digested the reality of Britain exiting a trading bloc that's also its biggest market. Those concerns extended into 2017, with the pound falling 1.3 percent against the dollar in February.

Bank Risks

Penny sees European banks taking a hit if Marine Le Pen wins France's presidential elections, instead of benefiting from wider loan margins as interest rates rise globally this year,.

“If she were to get in, it would probably be the end of the euro,” said Penny. “Le Pen is a risk factor that is already overshadowing European markets.”

The fund manager's wagering that Smart Metering Systems Plc will generate more growth from a roll out of smart gas meters in the U.K. while Taptica International Ltd. may get a boost from mobile advertising on Facebook Inc. First Derivatives Plc, which develops and provides technology services to financial firms, is a favorite growth stock and may gain another 10 percent this year, he said.

“Life continues, especially in technology with new products and services,” said the fund manager, who has a masters degree in engineering and economics from Oxford University. “To some extent they can transcend and mitigate some of these major macro factors.”

The U.K. Alpha Trust advanced 9.2 percent in 2016, erasing a two-year drop. It had gained 42 percent in 2013.

--With assistance from Andrew Bachmann

To contact the reporter on this story: Lukanyo Mnyanda in Edinburgh at lmnyanda@bloomberg.net.

To contact the editors responsible for this story: Neil Callanan at ncallanan@bloomberg.net, Andrew Blackman, Paul Armstrong