Investors have been well rewarded over the long term for venturing further down the market cap spectrum but there are some signs that a wider rotation into UK large-caps could be on the horizon, according to Chelsea Financial Services’ Darius McDermott.
FE Analytics shows that the FSTE 100 has made a 68.70 per cent total return over the past decade. The FSTE Small Cap, meanwhile, has risen 83.87 per cent while the FTSE 250 is up 132.52 per cent.
The FTSE 100 is lagging the other two indices over 15- and 20-year periods, by much wider margins. FTSE Small Cap and FTSE 250 are also leading over three and five years, but recent events such as the vote for the UK to quit the European Union means that the FTSE 100 has now pulled ahead over shorter time frames.
Performance of indices over 10yrs
Source: FE Analytics
McDermott, managing director of FundCalibre, thinks that the rotation away from small- and mid-caps could continue for some time to come, even if they have performed better than many would have expected this year.
“UK small- and mid-caps have significantly outperformed large-caps over the past 10 years or more,” he said.
“It was thought that the large-caps would come into their own post-Brexit vote and, with sterling plummeting against the US dollar, they have certainly done well. The FTSE 100 recently surpassed the 7,000 mark. However, small- and mid-caps have surprised too, shrugging off concerns about the economy, as the FTSE 250 reached all-time highs last week.
“The US election is an obvious worry for global markets, as is the Italian referendum, so any flight to perceived safety and any further depreciation in the currency or economic prospects could mean larger companies generally hold up better in the coming months.”
For investors looking to tilt their portfolios towards large-caps, McDermott highlights three funds with a bias towards this part of the market.
First up is Hugh Yarrow’s £1bn Evenlode Income fund, which holds the maximum FE Crown rating of five thanks to its superior performance in terms of stock picking, consistency and risk control over recent years.
Performance of fund vs sectors and index since launch
Source: FE Analytics
Regression analysis suggests that a significant proportion of the fund’s returns since launch have come from its exposure to FTSE 100 companies. The fund currently has the likes of Diageo, Unilever and Sage Group, as 60.6 per cent of the portfolio is held in large-cap stocks.
Yarrow and co-manager Ben Peters seek to invest in quality companies with resilient profit streams, sustainable growth profiles and limited capital reinvestment needs or reliance upon leverage. This is designed to leave them with stocks that have the ability to return cash to shareholders through dividends.
McDermott said: “This concentrated fund is not afraid to radically depart from its benchmark and ignore entire sectors. The investment process is extremely well defined. It is based on the simple, but effective, idea that over the long run quality will outperform and its high conviction long-term approach is refreshing to see.”
Evenlode Income has a clean ongoing charges figure (OCF) of 0.95 per cent and is yielding 3.30 per cent.
This £503m fund, which is managed by Michael Clark and David Jehan, is another that has achieved a significant proportion of its returns from FTSE 100 stocks.
Fidelity Enhanced Income resides in the IA UK All Companies sector and has the primary aim of providing income with the potential for some capital growth. To enhance its income stream, the fund uses an options overlay strategy to boost income at the expense of capital growth.
Performance of fund vs sector and index since launch
Source: FE Analytics
“This fund has an interesting process with few direct competitors. The enhanced income strategy does reduce the total return, but also the volatility of the fund,” McDermott said.
“Consequently, we think that reasonably cautious investors, whose primary concern is a higher income, could find this fund an attractive option.”
Before overwriting with options, some 70.8 per cent of the portfolio is in FTSE 100 names. All of the fund’s top 10 holdings are from the index, with AstraZeneca, GlaxoSmithKline and Reckitt Benckiser having the largest weightings.
Fidelity Enhanced Income has a 0.95 per cent OCF and is yielding 6.34 per cent.
McDermott’s final fund pick is Steve Davies’ £1.5bn Jupiter UK Growth fund. Davies has worked on the fund since January 2013, over which time it has made a 41.67 per cent total return, lagging both its average peer and the FTSE All Share.
Performance of fund vs sector and index under Davies
Source: FE Analytics
The fund focuses on two types of company: those with impressive future growth trajectories and those whose share prices have been under pressure but have the potential to recover.
“The process is remarkably simple, with the manager identifying both growth and recovery stocks through fundamental analysis, and then populating a concentrated portfolio with his best ideas,” its analysts said.
“However, over time Steve has stripped away parts of the process that were less successful, and the result is a fund that has performed well in a wide range of market conditions.”
Davies has just under 60 per cent of his portfolio in large-caps, with names such as Lloyds Banking Group, Dixons Carphone and Barclays appearing among its largest holdings.
Jupiter UK Growth has a 1.02 per cent OCF and is yielding 1.70 per cent.