Emerging markets, small caps and value-orientated funds could present interesting opportunities for those who believe equity markets are set for a resurgence, according to Victoria Hasler, head of research at Square Mile. 
Stronger-than expected GDP figures provided some optimism last month, as the UK economy grew in the second quarter of the year, according to data from the Office for National Statistics, despite expectations of a slowdown.
Meanwhile, last week the Bank of England announced an unexpected quantitative easing programme to accompany slashing interest rates to a new historic low of 0.25 per cent.
The UK’s QE programme was expanded by £60bn to £435bn, with the BoE able to purchase £10bn of corporate bonds.
ETX Capital’s Neil Wilson says the measures were not too dovish and not too hawkish, adding that the inclusion of corporate bonds in the QE programme is the big draw for investors.
“It’s going to deliver another sugar rush for the FTSE 100 and it’s no doubt going to spur additional borrowing by investment-grade companies who can then use the funds to finance share buy backs,” he said.
With all this in mind, Square Mile’s Hasler suggests three funds that investors should be paying close attention to if they feel bullish on equity markets.
Old Mutual UK Smaller Companies
“If you think the domestic economy in particular is going to do well then small caps are a good place to be because they have the biggest exposure to the domestic economy,” Hasler said.
“I also think in that scenario you buy some small cap exposure and the Old Mutual Smaller UK companies fund is pretty good.”
“Most of the large caps are more exposed to global economies so it’s a more pure play and also, when markets rally you’d expect smaller companies to rally more than larger companies.”
The £847m fund, run by FE Alpha Manager Daniel Nickols, has outperformed its sector (IA UK Smaller Companies) and benchmark (Numis Smaller Companies ex IT index) over the last five years, as the below graph shows.
Performance of fund vs sector and benchmark over five years
Source: FE Analytics
The fund was top quartile last year and is again this year so far, and over the last five years has provided the eighth best return among its peers.
While the fund is among the most volatile in its peer group, it is in the top quartile for the amount of positive (42) and negative (18) monthly periods over five years.
“This is a good experienced team investing in an area of the market where talented stock pickers can uncover good opportunities,” Square Mile research said.
Old Mutual UK Smaller Companies, which carries Square Mile’s AA rating, has a clean ongoing charges figure (OCF) of 1.03 per cent.
Investec UK Special Situations
“Or you could go for some kind of special situations fund - just because value has had such a terrible time of things that maybe if you think there’s going to be a good run for equities then value comes back,” Hasler said.
“So someone like Alastair Mundy at Investec Special Situations might be quite good,” she added.
As alluded to above, the fund has struggled in recent years, in the bottom quartile among its peers in 2015 as value stocks generally underperforming those displaying decent growth. However it performed well in 2011 and looking further back, was in the top quartile during the financial crisis in 2008 and for the recovery in 2009.
Performance of fund vs sector and benchmark since financial crisis
Source: FE Analytics
Value has been much unloved for the last few years as markets stagnated and managers focused on growth companies, but the £1bn fund could be in line for a pick-up if markets rebound and value becomes favourable again, according to Hasler.
“Mundy is able to avoid being distracted by the constant noise of the market and media, and to focus on where he adds value most effectively,” Square Mile research said.
“Given the contrarian philosophy and long term focus of the fund, investors should be aware that there may be times when its performance deviates substantially from the benchmark, particularly over short to medium time frames.”
Mundy counts the likes of Lloyds, RBS, Tesco and Morrisons as top 10 holdings (illustrating his value style). His fund, which also has AA rating from Square Mile, has a clean OCF of 0.85 per cent.
GS Emerging Markets Equity Portfolio
Hasler’s final choice is the Goldman Sachs Emerging Markets Equity Portfolio.
Though the two aforementioned funds are picks for investors who are bullish on the UK, she likes this fund (which has AA rating from Square Mile) because, if sentiment towards risk assets continues to be positive, then emerging markets should be a major beneficiary.
In this case, she suggests the fund because “it’s got a very good manager, it's a good fund and it’s quite punchy and if you think equity markets are going to do really well then that’s the one I would go for”.
The $755m fund, which has historically performed poorly during times of economic difficulty (most notably 2008 and 2011), has performed well recently as there has been a resurgence in popularity in emerging markets.
Performance of fund vs sector and benchmark over five years
Source: FE Analytics
The chart shows the fund underperforming in 2011, but picking up since, returning more than its peers and benchmark over the period.
Over three years, the five crown-rated fund is top quartile among its peers, returning 36 per cent to investors, while over five years it is just outside the top quartile.
“We believe the investment philosophy and process, which is to identify sound businesses at substantial discounts, is appropriate in emerging markets,” Square Mile research said.
“Investing in emerging markets is not without risks but we see this fund as a very sound long-term option for investors who are seeking broad exposure to the asset class.”
GS Emerging Markets Equity Portfolio has a clean OCF of 1.35 per cent.
