Smaller companies were one of the major beneficiaries of the bull market since 2011, with domestic facing companies in the FTSE Small Cap, AIM and 250 indices receiving a big boost from improving economic data and less risk-averse investors.
A rotation into cheaper large caps has seen them underperform this year, however.
Performance of indices in 2014
Source: FE Analytics
Though a number of experts believe small and mid-caps now look attractively valued following the sell-off, Metcalfe (pictured) – investment director at IBOSS – says the outlook still looks uncertain with the Scottish referendum and prospect of a base rate hike on the cards.
He isn’t allocating anything to pure small-cap funds as a result, preferring to invest in a manager with the flexibility to dip in and out of the asset class when he or she sees fit.“We would much prefer to go with quality genuine multi-cap funds instead of joining in the smaller companies debate,” Metcalfe said.
“The market is so distorted to the point that no-one quite knows where we are in the business cycle. Even when the data has been lousy, the market has reacted as if everything is ok.”
“Nothing has really changed since the sell-off in [in mid and small-caps] earlier this year. Of course, smaller companies managers say they offer loads of value at the moment, but you get a lot of shoulder shrugging from those who are more objective.”
Metcalfe and his team had used FE Alpha Manager Alex Wright’s Fidelity UK Smaller Companies fund, which has been the best performing portfolio in the IMA UK Smaller Companies sector since its launch in February 2008.
Performance of fund vs sector and index since Feb 2008
Source: FE Analytics
However, due to strong inflows, Fidelity closed the fund last year and Metcalfe removed it from his recommendation list as a result.
Instead of looking for a replacement, Metcalfe has identified multi-cap managers with a proven ability to add value by investing in small and mid-caps.
“We don’t know if smaller companies will keep underperforming, so we would rather go for a manager who can invest across the market and pay them to make the decision [about going into small-caps] for us,” he said.
FE Alpha Manager Andrew Jackson’s Ecclesiastical UK Equity Growth fund is one that Metcalfe has been using recently.
He started using the £170m multi-cap as a more nimble alternative to the £2bn Schroder UK Opportunities fund, which lost FE Alpha Manager Julie Dean last week.
Metcalfe became concerned about the size of the Schroder fund last year and says the growing AUM will have undoubtedly contributed to its recent underperformance relative to the IMA UK All Companies sector and the FTSE All Share.
He likes Jackson’s fund because it is run by an experienced manager, has a strong track record and is still under the radar of most investors.
Jackson holds 43.96 per cent of his four crown-rated fund in the FTSE 100, with the likes of Prudential, Legal & General, Rio Tinto and BP in his top-10 holdings.
He has 26.26 per cent in the FTSE 250 and 27.09 per cent in the FTSE Small Cap index.
The 90 stock-strong fund is very diversified, with the top-10 accounting for just 20 per cent of the total portfolio.
According to FE Analytics, Ecclesiastical UK Equity Growth has been a top quartile performer in the IMA UK All Companies sector since Jackson took over in October 2003.
It has returned 191.83 per cent over that time, beating its benchmark – the FTSE All Share – by 46.19 percentage points.
Performance of fund vs sector and index since Oct 2003
Source: FE Analytics
The fund also boasts top quartile returns, and has beaten its benchmark, over three, five, seven and 10 year periods, and has outperformed in seven of the last 10 calendar years.
However, due to its high-weighting to small and mid-caps, it has struggled this year, losing 3 per cent while the sector and index have ground out a small return. Ecclesiastical UK Equity Growth has ongoing charges of 0.84 per cent.
Metcalfe is also a big fan of the Franklin UK Managers’ Focus fund.
The portfolio differs to most others in the IMA UK All Companies sector as its responsibilities are split between Ben Russon and Colin Morton, who focuses on blue-chip stocks, and Richard Bullas and FE Alpha Manager Paul Spencer, who focus on small and mid-caps.
The four managers oversee around 10 stocks each, making the £70m fund one of the more concentrated in the sector.
Franklin UK Managers’ Focus was launched in September 2006. Our data shows it has been a top quartile performer over that time with returns of 95.4 per cent, comfortable beating the FTSE All Share which has returned 58.37 per cent.
Performance of fund vs sector and index since Sep 2006
Source: FE Analytics
It is also top quartile over one, three and five years.
Despite its 50 per cent weighting to small and mid-caps, it has held up better than most in 2014, with returns of 1 per cent. However, it is lagging against the index.
The managers count FTSE 100 stocks like AstraZeneca and Imperial Tobacco as top-10 holdings, as well as mid and small-caps such as Bovis Home Group, Restaurant Group and Spire Healthcare Group.
Its OCF is 0.87 per cent.
