Investors should chiefly be invested in UK mid and small cap equity funds, according to Mark Dampier (pictured), head of research at Hargreaves Lansdown.
UK investors are likely to head to investments in the FTSE 100 mega-cap biased funds or passives to provide the core exposure for their portfolio, favouring the huge international firms that make up the index over the smaller more domestic names lower down the cap scale to provide their income and growth.
One of the major reasons for that is because smaller companies are generally more volatile and also less researched than their large-cap rivals, therefore pushing investors to the perceived safety of the FTSE 100 and its well-established names.
However, according to FE Analytics, mid and small caps have been the best performing part of the broader UK equity market over the past 30 years, as shown in the graph below with the mid cap part of the market – the FTSE 250 – by far the best.
Performance of indices since 1985
Source: FE Analytics
This is also true over 10 and 20 years but it has been the small cap end of the market that has dominated over five and three years.
Dampier, who is speaking in broad terms and not adjusting for different investors’ needs such as income requirements or capital protection, said about investing in this part of the market:
“You have to be patient and my view is that most people are just patient. I just think mid and small-caps will always be a good area to be invested in over the longer term. I think it is the main area to invest in on the whole.”
Dampier thinks three managers in the smaller and medium sized companies space stand out and here we take a look at their portfolios.
FE Alpha Manager Kerr has managed the £322m Old Mutual UK Dynamic Equity fund since 2009, since which he has returned a hefty 230.37 per cent – the fourth best return in the IA UK All Companies sector over this period.
Performance of fund, sector and index since June 2009
Source: FE Analytics
The fund is relatively unique compared to its peers as Kerr has the ability to take short positions in stocks he thinks are set for a period of weakness which adds an extra engine to add alpha to the portfolio, especially in volatile markets. This has clearly paid off for the manager over the medium term.
While this has worked well over the boom years from 2009 onwards, it has also shown to work well in the choppy market of 2015 with the portfolio sixth out of 272 funds in the sector year to date.
Currently, Kerr is shorting just five companies within his portfolio compared to his 48 long positions. It is a fairly concentrated fund, with Old Mutual UK Dynamic Equity’s top 10 positions accounting for more than 40 per cent of its total AUM.
The fund has a clean ongoing charges figure [OCF] of 1.15 per cent.
The £540m Schroder UK Dynamic Smaller Companies fund is headed by the FE Alpha Manager duo of Paul Marriage (since 2006) and John Warren since (2010).
It is top quartile over five years and the second best performing fund in the UK small-cap sector since Marriage took over with returns of 261.64 per cent. It has doubled the sector average return and beaten the FTSE Small Cap index by almost 200 percentage points too.
Performance of fund, sector and index since 2006
Source: FE Analytics
Marriage and Warren’s performance has also been highly consistent with the fund generally ahead of both the market and its peers on an annual calendar basis.
The exception is when in 2014 the group decided to hard-close the fund, prompting huge outflows. This also coincided with a sell-off in small caps, meaning the fund was bottom decile with losses 8.81 per cent.
Nevertheless, with the fund’s AUM having almost halved since its hard-closure and now it is again open to investors, Square Mile Research note the pragmatism of the managers’ investment style.
“For example, although in the main they look to purchase quality businesses they do not lose sight of the fact that this, on its own, is not a guarantee of making money,” Square Mile said.
“Therefore, they also need a company to have an investment angle, such as management change or restructuring, which can help drive a reappraisal of the valuation by the market. There is a clear and defined investment process in place, concerning both what the managers look for and what they avoid.”
The fund has a clean OCF of 0.91 per cent.
FE Alpha Manager Giles Hargreave runs three smaller companies funds: Marlborough Nano Cap Growth, Marlborough UK Micro Cap Growth and Marlborough Special Situations.
He is one of the best known fund manager in the smaller cap space and has beaten his peer group composite in 14 out of the last 15 full calendar years. This led him to be the most consistent FE Alpha Manager of the millennium.
He has managed the £924m Marlborough Special Situations fund since July 1998, over which time it has returned near 2000 per cent. This means it has made more than doubled the gains of its nearest rival and beaten the average fund by more than five times.
Performance of fund, sector and index since 1998
Source: FE Analytics
The fund is highly diversified with more than 200 stocks. It is also top quartile in the IA UK Smaller Companies sector over one, five and 10 years, making it one of the most popular in its asset class.
However, in 2015 it is second quartile but way ahead of the index FTSE Small Cap index’s gain of 7.15 per cent with a return of 14.41.
The FE Research team have included this fund on the FE Select 100 believing the fund is one of the strongest UK funds in terms of performance and quality of its investment team, given then Hargreave started his career in 1969 and the analysts collectively have 125 years of market experience between them.
They also like the manager’s diversified approach, as Hargreaves holds some 215 stocks while his top 10 positions account for just 15 per cent of the his fund’s total AUM.
“It is unusual to have such small amounts of money invested in high-conviction positions, but as the share prices of smaller companies can fluctuate more violently, this diversity limits the impact of a single high risk stock. It also highlights the manager’s ability to generate investment ideas due to the team’s large resource in the smaller companies area.”
The fund has a clean OCF of 0.8 per cent.