Small-cap biased funds such as CF Miton UK Multi Cap Income, PFS Chelverton UK Equity Income and Unicorn UK Income top the IA UK Equity Income sector for both total returns and volatility over recent years, according to research by FE Trustnet, after large-caps suffered from declining investor sentiment.
Data from FE Analytics backs up the common view that small-caps are more risky than blue-chips over the long term, albeit while offering the potential for significantly higher returns. Over the past 20 years, the FTSE Small Cap index has made a 262.66 per cent total return while the FTSE 100 has risen 210.15 per cent.
However, the FTSE Small Cap’s annualised volatility over this two-decade period has been 17.38 per cent, compared with 14.01 per cent for the FTSE 100. When it comes to maximum drawdown – or the most an investor would have lost if they bought and sold at the worst possible times – it stands at 48.03 per cent for small-caps but 'just' 44.41 per cent for large-caps.
Performance of indices over 3yrs
Source: FE Analytics
More recently, however, this trend has not been apparent: if we look at both indices over the past three full years then UK small-caps have been less volatile than their larger peers. FE Analytics shows that the FTSE Small Cap’s annualised volatility was just 7.97 per cent over this period, compared with the FTSE 100’s 11.52 per cent.
This has come during a period of stark outperformance from the smaller companies. While the FTSE Small Cap has surged 27.62 per cent over the past three years – thanks to renewed confidence in the UK economy – concerns over the longevity of the bull market and fears of slowing global growth have caused the FTSE 100 to post a total return of just 4.80 per cent.
The following table shows the members of the IA UK Equity Income sector that are sitting in the first quartile for both total return and annualised volatility.
As you can see, it is topped by Gervais Williams and Martin Turner's £585.6m CF Miton UK Multi Cap Income fund, which returned 73.18 per cent across the space of 2013, 2014 and 2015 (making it the sector’s best performer) with annualised volatility of just 6.71 per cent.
Source: FE Analytics
While the five FE Crown-rated fund has ‘UK multi cap’ in its name, a look at the underlying weightings shows a definite bias away from the country’s largest businesses – reflecting the fact both managers have built a strong reputation in investing in the small-cap space.
Just 15.4 per cent of the portfolio is in FTSE 100 names with 30.9 per cent in the FTSE AIM, 17.8 per cent in the FTSE Small Cap and 21.1 per cent in the FTSE 250. Top holdings include professional services provider Charles Taylor, window purveyor Safestyle UK and litigation finance firm Burford Capital.
The fund isn’t not alone in looking outside the FTSE 100 for attractive income plays, though. Marlborough Multi Cap Income, MFM Slater Income, PFS Chelverton UK Equity Income and Unicorn UK Income are all known for taking significant positions in small and mid-cap stocks.
This has helped push them to the top of their peer group, as these parts of the market have rallied harder over recent years than international-facing mega-caps, which have had to contend with slowing growth in China, plunging commodity prices, mounting geo-political risks and diverging monetary policy from major central banks.
Performance of funds vs sector and index over 3yrs
Source: FE Analytics
However, the strong run in these kinds of funds does not necessarily mean investors should fill their portfolios with them – although few are suggesting that small-caps are going to encounter drastic problems in the medium term.
Richard Troue, head of investment analysis at Hargreaves Lansdown, said: “In terms of the next three years I don’t see an imminent catalyst that would knock these funds off course and on the whole I would suggest holding for the long term and taking advantage of any volatility either way to rebalance your mix of funds accordingly.”
“Most investors are probably better off looking to blend a few equity income funds together, not only to diversify across the market cap spectrum, but also to get exposure to different fund manager styles and approaches.”
“This should help smooth returns somewhat and achieve a good balance between receiving a high income now, growing that income over the long term and also achieving some capital growth.”
Troue recommends blending small-cap equity income funds with those holding more in larger-cap names. He highlights two of the names on the list – Rathbone Income and Troy Trojan Income – as being possible contenders for the latter role.
As appearing on the list shows, both funds have outperformed the bulk of their peers when it comes to both total return and volatility over the past three calendar years.
Performance of funds vs sector over 3yrs
Source: FE Analytics
These funds have higher weightings to large-caps – Carl Stick’s Rathbone Income fund has 55.65 per cent in the FTSE 100 while Francis Brooke’s Troy Trojan Income has more than 70 per cent of assets in mega and large-cap names.
Both are highly regarded by the FE Research team and appear on the FE Invest Approved list, where their risk-conscious approach to investing, long-term horizon and concentrated portfolios are highlighted as strengthens.
Other funds Troue thinks could successfully blended with small-cap equity income portfolios, include Neil Woodford’s CF Woodford Equity Income and Adrian Frost, Adrian Gosden and Nick Shenton’s Artemis Income funds.
These have also built a strong track record (in Woodford’s case, the bulk of it comes from his time at Invesco Perpetual) on the back of investing in the UK’s largest dividend-paying names.
