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Buoyed by their limited exposure to slowing emerging-market growth, a rout in commodities and a banking crisis, the U.K.’s small and mid-cap shares outperformed their bigger peers in all but one of the years since 2008 and surged more than three times as much from a low that year through 2015. That trend has started to reverse.
Investors have punished the FTSE 250 Index more than the FTSE 100 Index this year on concerns about growth prospects for smaller companies if Britain decides to exit the EU. Given their reliance on both domestic and European demand, not only could a so-called “Brexit” cause them to miss out on any benefits of a European economic rebound, but they’d also take the hit from any upsets in the British recovery.
“The darlings of the U.K. stock market of the past few years will have a greater exposure to a Brexit,” said Justin Urquhart Stewart, co-founder of Seven Investment Management in London. His firm oversees about $13 billion. “It might be a good idea to prepare for that before everyone rushes out of the door. It’s definitely a risk you should be factoring into your portfolio.” [...]
In the event of a “Brexit,” Credit Suisse recommends watching 16 British companies with the biggest earnings exposure to Europe. Of those, only five belong to the FTSE 100, while the rest are either members of the FTSE 250 or too small to be included in either gauge. With more than 60 percent of their revenue coming from Europe, Thomas Cook Group Plc, Berendsen Plc and Shanks Group Plc depend most on the region, according to the bank. All three are in the FTSE 250. [...]
Although lower valuations provide a good entry point for investors, smaller-cap shares will be especially vulnerable to increased volatility as the vote approaches, according to Hassium Asset Management’s Yogi Dewan. A measure tracking U.K. stock swings has jumped 35 percent this year, more than a gauge tracking volatility in euro-area equities.
“Brexit leads to a lot of uncertainty and markets hate that,” said Dewan, Hassium’s chief executive officer. “Even if the U.K. doesn’t leave Europe, all this noise and politics will not be helpful at all for companies on the brink of reaping the benefits from a pick up in European demand.”