UK’s uncertain political future leads investors to find safety in large caps

The uncertain future of the UK economy following the first hung Parliament in 30 years has led to a sell-off in small-cap stocks as investors seek safety and overseas exposure from blue chips.

The FTSE 250 was down 4.75% to 9,436 in late trading at the end of last week, while the FTSE SmallCap index fell 3.1% to 2,876.

Volatility and contagion fears over southern European economies also drove investors into large caps, especially names with heavy overseas exposure.

However, this flight to safety and liquidity has pushed down small-cap valuations and driven some multi-cap managers to seek opportunities in this area.

“A sell-off like this always throws up opportunities,” says Julian Chillingworth, the chief investment officer at Rathbones. “We do like certain non-FTSE names like Halfords, and we are reviewing if the market has much further to fall. If it does there may be opportunities that come up in industrial names in the mid caps.

“But at the moment we are keeping the Blue Chip Income and Growth fund heavily orientated towards non-sterling earnings, particularly where an exposure to growth areas is possible. The fund has over 85% of its assets in FTSE 100 companies.”

Deryck Noble-Nesbitt of Close Asset Management says it has been a bear market for small caps since September 2009, caused by fears over the budget deficit, private sector debt, future tax hikes and political uncertainty.

“I feel these fears are creat-ing some interesting investment opportunities in the domestic space,” he says.

Noble-Nesbitt has 75% of his Special Situations fund in stocks with a market cap of less than £250m and this is rising. “Generally I prefer to buy stocks when markets are fearful,” he adds.

Threadneedle’s mid-cap specialist Simon Haines points out that despite the problems the UK faces, 70% of its corporate earnings come from outside the country. Bestinvest senior investment adviser Adrian Lowcock echoes this view, advising his clients to sell UK small caps and buy FTSE 100 names, because these overseas earners will benefit from a continuing fall in sterling.