Skip to the content

UK small-cap funds and trusts thrive in spite of FTSE slump

25 June 2015

Following a disappointing year, UK small-cap portfolios are experiencing a rapid surge following political certainty and a strong UK economy.

By Lauren Mason,

Reporter, FE Trustnet

UK small-cap funds and trusts have seen a significant uptick in performance over the past few months despite a sell-off in most global markets including the FTSE 100, according to data from FE Analytics.

Small and micro-caps have suffered a particularly lacklustre period over the last year or so, with the FTSE AIM All-Share index falling 19.03 per cent between March 2014 and March 2015.

Performance of indices from March 2014 to March 2015

 

Source: FE Analytics

This performance was a far cry from 2013, when the index achieved positive returns of 21.33 per cent and the IA UK Smaller Companies sector returned almost 40 per cent.

However, wider macroeconomic concerns as well as the profit-taking after the strong run led more investors to take their money out of the higher-risk asset class and pile into defensive blue-chip stocks.

This led to cheaper valuations for small-caps and some financial experts began to view buying into the asset class as a stellar opportunity.

In an article published in March, Hargreaves Lansdown’s Mark Dampier (pictured) told FE Trustnet that he was tipping the “unloved” market for a rebound, attributing the disappointing performance to momentum players driving its underperformance.

What’s more, after the IA UK Smaller Companies sector’s poor start to 2015 Whitechurch Securities head of research Ben Willis said concerns in the market were short-term and there would be plenty of investment opportunities on a stock-by-stock basis.

Over the last three months, small-caps have indeed improved, with the IA UK Smaller Companies sector delivering an average return of 6.85 per cent and outperforming the FTSE 100 by 8.34 percentage points.

Performance of sector vs indices

Source: FE Analytics

A significant reason for this outperformance is the UK general election resulting in a pro-business majority party, creating stability and certainty in the market – especially when it comes to areas such as domestically focused small-caps.


However, can this outperformance continue? Neil Shillito, investment director of SG Wealth Management, believes that it can.

“As we’ve just experienced, [small-caps] are affected by macro views, so clearly a lot of the underperformance prior to the election was to do with political uncertainty,” he said.

“Also, the latest buzzword in the market is ‘bond proxies’ and a lot of money poured into the utilities, staples and other defensive stocks, where investors are seeking the relative certainty of a sustainable dividend in lieu of the fact that they can’t buy bonds at a reasonable price.”

“Small-caps have underperformed, but they’re coming back now. Why is it coming back? Greater political certainty, and I think the news over the last two days will help with that. Let’s face it, the Greece situation is just papering over the cracks, but markets are by driven short-term sentiment and they don’t look into whether it’s true or not – they just say ‘the sentiment looks good for the next two days’.”

“I think the news about the eurozone is probably going to help and investors are likely to go back to riskier assets. Small-caps, I think, is a world where one should not be particularly concerned about macro and be much more concerned about fundamental analysis of the companies themselves.”

Shillito also believes the small-cap space is an area all investors should have some exposure to but how much of their portfolio they choose to allocate should depend entirely on their personal appetite for risk.

“To ignore the small-cap market from the point of view that it has had its day, we don’t view it that way. Yes, it might underperform for a while but it’s got nothing to do with the fundamentals and everything to do with the sentiment.”

This bottom-up view on small-caps can be shown through the performance of numerous small-cap funds that have managed to retain strong returns despite the challenging headwinds.

Out of all the small-cap funds in the Investment Association universe, the top performers over five years are Fidelity UK Smaller CompaniesAXA Framlington UK Smaller Companies and Schroder UK Dynamic Smaller Companies, all of which have significantly outperformed the IA UK Smaller Companies sector and their benchmarks.

Performance of funds vs sector and indices over 5yrs

Source: FE Analytics

Dampier agrees that people can become far too index-focused and that choosing a small-cap fund should be about the manager’s investment process and their ability to stock-pick as opposed to how well the market is performing.


“Speaking to [Schroders’] Paul Marriage the other day, his view is that the strong performance will continue,” he said.

“You have got the election result which is probably favourable but actually, he also made the point that small companies used to be pessimistic on forecasts. But when he’s been speaking to management in the last few months, they’ve become more optimistic and, if anything, they’re revising earnings forecasts up.”

“This is not a bad time to enter the market, which is interesting because most private clients have been selling like hell. In fact, I argued with someone about six weeks ago who had hardly made anything and he was moaning about it but he’d barely had the fund for 18 months, which is a ridiculous period of time.”

“That is one thing in the market, there are a lot of momentum players and as soon as the sector goes off the boil, they all move out.”

Looking over the past three months and the MFM Techinvest Special Situations has the highest returns in the open-ended small-cap space with a 12.3 per cent total return.

However, this is a far cry from the £3.3m fund’s performance over the long-term, as it has underperformed its sector over five years, delivering a bottom-quartile return of 104.12 per cent.

Another fund that has benefitted from the recent change in sentiment is the Unicorn UK Smaller Companies fund, which has almost doubled the performance of its sector average and benchmark over three months.

Performance of fund vs sector and benchmark over 3months

Source: FE Analytics

Of course, it isn’t just open-ended funds that have seen a surge in returns.

Over the last three months, when sentiment first began changing, the IT UK Smaller Companies sector has achieved returns of 9.7 per cent, outperforming the FTSE 100 by 11.19 percentage points.

Strategic Equity Capital and Dunedin Smaller Companies IT has led returns in the sector over the time frame in question, with respective gains of 24.32 per cent and 17.66 per cent. As the graph below shows, this is significant outperformance of the sector average and large-caps.


Performance of trusts vs sector and index over 3months

Source: FE Analytics

However, as more and more people buy into smaller companies trusts, valuations will inevitably become less attractive.

On average, UK smaller companies trusts are currently trading at a discount of 10.4 per cent, according to data from the Association of Investment Companies (AIC).

Despite this, a handful of small-cap and micro-cap trusts are already trading on a premium, including Miton UK Microcap which is currently on a significant premium of 8 per cent.

Dampier says trusts in general are proving to be more popular investment vehicles than funds at the moment, particularly with discretionary wealth managers.

“[Wealth managers] seem less concerned about ratings of premiums and discounts so they just carry on buying because they have a model portfolio. I don’t think that’s necessarily right, but you do have to watch that carefully,” he warned.

“Undoubtedly with a fair wind they could all go premium but I certainly wouldn’t want to buy them at premiums.”

AXA Wealth’s Adrian Lowcock adds that before this happens, there is still scope to benefit from narrowing discounts in the small-cap space.

“On one side you’ve got that area where there are high valuations and there are a few in the micro-cap space, but there are also some trading at a discount,” he explained.

“You should probably expect trusts to stay at a discount, as that’s the usual thing. I think that some trusts are exceptions, especially if they are well-known and have a stellar reputation.”

“[Small-cap trusts] have the potential to narrow because some are wider than others, but that’s natural. There is potential and you would expect that, as investors move into that space, for those to narrow.”

ALT_TAG

Editor's Picks

Loading...

Videos from BNY Mellon Investment Management

Loading...

Data provided by FE fundinfo. Care has been taken to ensure that the information is correct, but FE fundinfo neither warrants, represents nor guarantees the contents of information, nor does it accept any responsibility for errors, inaccuracies, omissions or any inconsistencies herein. Past performance does not predict future performance, it should not be the main or sole reason for making an investment decision. The value of investments and any income from them can fall as well as rise.