Investors could use the increased uncertainty surrounding the UK’s future relationship with the EU to up their exposure to struggling UK small-cap funds, according to Premier’s Simon Evan-Cook, who has been doing just that in his funds of funds. 
Many suggested that the possibility of a Brexit would cause volatility in the UK market in 2016 and that has certainly been the case so far.
Though the bookies are still backing a ‘remain’ vote, the perceived likelihood that the UK will vote to leave the EU on 23 June has already caused sterling to weaken and pushed investors to start pulling their money out of UK equity funds.
Indeed, data from the Investment Association shows that the UK was the most sold region in Q1 with some £594m being redeemed from domestic equity funds. Outside of the UK, average outflows from equity funds in the IA universe in the first three months of the year were just £116m.
Net retail sales of equity funds in (in £m) Q1 2016
Source: The Investment Association
This trend has had a greater effect on funds with a smaller company – and typically domestic – bias. FE data shows, for example, that while the FTSE 100 index is up 0.5 per cent, the IA UK Smaller Companies sector average is down 2 per cent. It has also returned half as less as the blue-chip index since markets bottomed in mid-February.
Given investors are now offered a better margin of safety by investing in UK smaller companies due to their lower valuations, Evan-Cook says now is a good time to buy into funds that invest outside of large-cap land.
“We have been topping up our exposure to UK small-caps, which have been left behind more recently,” Evan-Cook said.
“We have seen that international investors are staying away from anything linked to a potential Brexit so we are using the uncertainty to add to some of our existing holdings. Small-caps are having a little bit of an episode and we think this is an example of investors acting on a theme that is not necessarily warranted.”
In this article, we take a closer look at the funds Evan-Cook has been buying to cash in on the current Brexit uncertainty.
This is a fund that has seen a real revival in fortunes following a change in manager.
Having been one of the worst performers in the IA UK Smaller Companies sector, the five-crown rated Franklin UK Smaller Companies fund now sits in the top quartile and some 20 percentage points ahead of its benchmark since Richard Bullas and FE Alpha Manager Paul Spencer took charge of the portfolio in June 2012.
Performance of fund versus sector and index under Bullas & Spencer
Source: FE Analytics
It has also outperformed the sector and index in each full calendar year since they have been at the helm.
The managers re-organised the portfolio by chopping down the number of holdings and ditching its excessive micro-cap holdings. The managers blend value and growth in their investment approach, using a top-down view to guide their stock-picking.
Though this has worked over the medium term, the fund has been one of the sector’s worst performers so far this year with losses of 6.27 per cent compared to a 0.96 per cent fall in its benchmark.
However, Evan-Cook has been a long-term backer of the fund and thinks the recent losses constitute a buying opportunity. Franklin UK Smaller Companies has a clean ongoing charges figure (OCF) of 0.83 per cent.
Evan-Cook has also been a long-term backer of this four crown-rated fund.
According to FE Analytics, FE Alpha Manager Alex Wright’s £386m Fidelity UK Smaller Companies fund has been the best performing fund in the peer group since its launch in February 2008 with gains of 300.68 per cent, beating its benchmark by 175 percentage points in the process.
Performance of fund versus sector and index since launch
Source: FE Analytics
FE data shows the fund has also outperformed the sector average and its benchmark in each of the last eight calendar years.
Unlike many of his peers, Wright – who now also runs two other multi-cap funds at Fidelity – takes a value/contrarian approach to the market whereby he buys unloved companies where he sees a catalyst for positive change and then hold the stock until its true value has been realised.
This approach to investing has largely struggled of late and though Wright’s fund – which has also has the best risk-adjusted returns in the sector since inception – is second quartile year to date, it has lost a percentage point more than the index.
It must also be noted that the fund was soft-closed once again earlier this year, meaning that new investors may struggle to buy Fidelity UK Smaller Companies. Nevertheless, it has a clean OCF of 0.95 per cent.
This a small-cap value fund that is still open to investors, however.
The £155m Aberforth UK Small Companies fund has been managed by Alastair Whyte and Richard Newbery since its launch in March 1991 who have, in turn, been joined by others to make a team of five. Since inception, the fund has returned some 1,900 per cent compared to a 1,000 return from its benchmark.
However, its deep value focus has meant the fund has struggled over more recent time frames. Indeed, Aberforth UK Small Companies is now third quartile over three, five and 10 years and bottom of the sector over 12 months.
Performance of fund versus sector and index over 1yr
Source: FE Analytics
Nevertheless, Evan-Cook likes the experienced management team and approach to the market, noting that the fund has faced a style headwind over recent years.
The managers largely focus on heavily out of favour companies within the UK small-cap space and typically hold 80 stocks. They are also highly disciplined, sticking to their process even through some very poor periods for value investing.
Currently, the managers are finding better opportunities towards the lower end of the index with the fund overweight FTSE Small Cap stocks and underweight FTSE 250 companies relative to its benchmark.
Aberforth UK Small Companies has a total expense ratio of 0.86 per cent.