"UK mid/smaller company funds had a very strong year in 2012 and we believe that the outlook remains positive, with the potential to benefit from M&A activity," Cade said.
"There are numerous well-managed smaller companies funds on wide discounts, including BlackRock Smaller Companies and Henderson Smaller Companies, which have a focus on quality growth companies, or Aberforth Smaller Companies, which has a well-defined value approach."
Retail sales of smaller companies funds were marginally positive last year, but investors still prefer portfolios that deliver income, despite the fact that many are trading on premiums.
Cade warns that although income trusts' high ratings remain sustainable in the short-term, investors risk poor performance in the longer term if they go for trusts trading at close to net asset value (NAV).
"We believe that there is a risk that investors buying stocks on high premiums will endure disappointing total returns over the medium-term," Cade said.
Henderson Smaller Companies
Henderson Smaller Companies had an excellent 2012, rising 47.9 per cent over the year as the Numis smaller companies index rose 22.46 per cent.
Performance of trust vs sector and benchmark in 2012
Source: FE Analytics
Despite this, and the fact that it has five FE crowns, the trust is currently trading on a huge discount of 15.5 per cent, according to the AIC.
The fund has made 88.03 per cent over the past five years and 451.92 per cent over the past decade, comparable to the returns of the best emerging markets funds.
It has a total expense ratio (TER) of 0.52 per cent.
Manager Neil Hermon has run the fund since 2002.
BlackRock Smaller Companies
The BlackRock Smaller Companies trust returned 30.1 per cent last year, more than the 22.46 per cent of its Numis + AIM index.
The trust also has five FE crowns, although it is trading on a slightly narrower discount of 12.1 per cent.
It is another trust to have kept the same manager for a long time, with Mike Prentis in charge since September 2002.
Prentis has beaten the returns of the Henderson fund over three, five and 10 years, returning 107.05 per cent over the shorter period and 521.4 per cent over a decade.
The TER on the fund is slightly higher, at 0.7 per cent.
Aberforth Smaller Companies
Cade also likes Aberforth Smaller Companies, which is currently sitting on a discount of 14.9 per cent.
"Aberforth’s performance had been dull in recent years as value has been out of favour, and its bias towards small caps was a drag," Cade said.
"However, it performed well in 2012, with the NAV up 32 per cent. We believe it is far more attractive than Dunedin Smaller Companies, which is trading on a 13 per cent premium following a significant re-rating over the past year."
Bestinvest’s Jason Hollands told FE Trustnet earlier this month that he was concerned about the size of the fund and preferred Fidelity Special Values as an alternative.
Although the trust has provided lower returns over the past three years – just 50.24 per cent – Cade still rates it highly. The TER is 0.88 per cent and it has a yield of 2.80 per cent.
Fidelity Special Values
Cade agrees with Hollands that Fidelity Special Values stands out among growth funds.
"Alex Wright took over as manager of Fidelity Special Values from Sanjeev Shah on 1 September 2012, reflecting the board's desire to differentiate the fund and invest a greater proportion of assets in small/mid cap stocks," said Cade.
"Alex has 11 years’ experience at Fidelity and has a good track record as manager of the Fidelity UK Smaller Companies fund. He employs a value and contrarian style, seeking to purchase unloved stocks with a clear catalyst to create growth."
"At the same time, he seeks downside protection through assets (cash and fixed assets), cheap valuations (price to book, EV/sales), and barriers to entry (long-term contracts and visible order books)."
The TER on the fund is 1.14 per cent and it is trading on a discount of 11.9 per cent.
Crystal Amber
A more left-field pick is the Crystal Amber fund, a Guernsey-domiciled vehicle that is a member of the AIC.
"The investment approach of Crystal Amber has little in common with a typical UK smaller companies fund and we believe that it is an interesting alternative," Cade said.
"Rather than a traditional portfolio approach, the fund takes stakes in a handful of undervalued companies and seeks to encourage boards to take steps to realise this value."
"Since its launch in mid-2008, the fund has exited several profitable investments following corporate action, including Pinewood Shepperton, 3i Quoted PE, Chloride, Delta and Kentz."
"These gains have been partly offset by a substantial loss on JJB Sports, which has had an impact on investor sentiment towards the fund. In our view, however, the strong performance in 2012 (NAV up 35.3 per cent) should help Richard Bernstein to rebuild investor confidence."
Data from FE Analytics shows that although the trust had a strong 2012, earlier years were disappointing.
It underperformed its benchmark in 2009 and lost 19.1 per cent in 2010, when the index made 28.41 per cent.
Performance of trust vs benchmark since launch
Source: FE Analytics
The current discount on the fund is 14.9 per cent and the TER is 2.62 per cent.