Following a sustained period of stellar outperformance, an increasing number of investors have been turning to funds which invest in smaller UK dividend-paying companies.
Data from FE Analytics shows these types of funds, such as Marlborough Multi Cap Income, PFS Chelverton UK Equity Income and Unicorn UK Income, are among the top selling IMA UK Equity Income funds over the last 12 months with many doubling in size as more money has poured in.However McQuaker, who heads up Henderson’s multi asset fund range, warns that mid and small-cap income funds are likely to underperform over the medium term.
“You have to question the timing [of buying now], because in the shorter term they won’t be able to replicate their strong returns or the returns that a lot of investors have become used to,” McQuaker (pictured) said.
Multi-cap income funds have been some of the major beneficiaries of the rally in UK equities over recent years, with smaller companies thriving as investors’ appetite for risk increased and as the UK economy strengthened.
According to FE Analytics, PFS Chelverton UK Equity Income, Unicorn UK Income and Marlborough Multi Cap Income – which all have a heavy bias towards smaller companies – have been the three best performing funds in the sector over the last three years.
CF Miton UK Multi Cap Income has a slightly shorter track record, but the fund – along with the Chelverton, Unicorn and Marlborough funds – has been one of the top four performing portfolios in the sector since its launch in October 2011.
Performance of funds vs sector and index since Oct 2011
Source: FE Analytics
However, as the graph above shows, those funds have mostly struggled in 2014 as, due to issues such as high valuations, talk of interest rate rises and geo-political risks, smaller companies have underperformed over recent months.
Despite that, our data shows all four of those portfolios have attracted a lot of retail money over the past 12 months.
Source: FE Analytics
McQuaker, who has recently sold his stake in the CF Miton UK Multi Cap Income fund, says investors who have upped their exposure to smaller companies funds will rue their decision as small and mid-caps will continue to struggle.
“I think if people are taking a five-year view, because a lot of these small and mid-cap funds have a lot of quality management teams, they will do quite nicely. However, these types of funds, even those with an income bias, will have a period of consolidation over the coming year or two.”
“Mid and small caps have performed stunningly well over recent years. We had been quite significantly exposed to them, but given where valuations are now and how well they have performed; I don’t think you can expect them to have a re-run of those returns.”
Chris Spear, managing director at Spear Financial, says if investors are buying multi-cap income funds now and aren’t planning on selling them over the next 10 years or so, they shouldn’t be worried about timing the market.
However, he is concerned that a lot of investors have bought multi-cap income funds for the wrong reasons.
“Remember the FCA’s guideline, ‘past performance is no guide future performance’? Well, I think a lot of people have ignored that and thought ‘hasn’t that done well, I want to get in on that’,” Spear (pictured) said.
“It’s only human nature I suppose, but I had a number of clients in AIM stocks for the tax incentive last year and some of them were up 40 to 50 per cent. I’m no scientist, but I do know that what goes up is going to come down at some stage.”He added: “I think that is what we are seeing now.”
Spear admits that it isn’t just retail investors who fall foul of backing funds that have already performed well, as many advisers and research groups will tend only to invest with funds that have continually outperformed over a three or five year period.
It is interesting to note that in the Sanlam Equity Income Study, a number of funds have been removed from its White List of recommended funds due to the area of the market they invest in.
“Aviva Investors UK Equity Income and Troy Trojan Income, previously long-term members of the White List, sourced the majority of their opportunities in larger capitalisation stocks, which have been less in vogue over recent years and hence we have seen them fall away into the Grey List,” Paul Surguy, head of managed funds, said.
To replace his holdings in CF Miton UK Multi Cap Income and Schroder UK Dynamic Smaller Companies – which he also sold recently – McQuaker has been upping his exposure to Artemis Income and Richard Buxton’s Old Mutual UK Alpha fund.
McQuaker rates Buxton and, like Canaccord Genuity’s Justin Oliver, says he is one of the best UK managers in the business as he outperformed without just upping his exposure to small and mid-caps. Instead, Buxton has held nearly all of his portfolio in FTSE 100 names.
Performance of fund vs sector and index since Dec 2009
Source: FE Analytics
“He has essentially been sailing against the wind,” McQuaker said.
McQuaker has been adding to the £6.7bn Artemis Income fund, which is headed up by Adrian Gosden and FE Alpha Manager Adrian Frost, due its bias towards large cap dividend paying companies.
“They said the reason they have 84 per cent in the FTSE 100 because it is the only place they think offers decent value. I concur, I think they have the correct view,” he said.
The fund has underperformed over 12 months, but has beaten the IMA UK Equity Income sector and the FTSE All Share over three, five, seven and 10 year periods.
