Small and mid cap funds have been some of the main beneficiaries of the recent rally.According to FE Analytics, the IMA UK Smaller Companies sector and the FTSE Small Cap index have returned more than 215 per cent over five years.
As the graph below shows, those gains have been almost uninterrupted.
Performance of sector and index over 5yrs
Source: FE Analytics
A number of managers – such as Miton’s Gervais Williams – say small caps can continue to perform well as they are still relatively under-owned. However, McQuaker says that now is a good time to rotate money out of small cap funds into large cap ones.
He says not only will larger companies offer better protection during bouts of volatility, but that because many of them have been left behind in the rally, there is now good value to be found within the sector.
“In the UK, we have had quite a significant exposure to mid and small caps. We have done very well out of funds like Cazenove Smaller Companies or Old Mutual UK Dynamic, for instance,” McQuaker said.
“At the margin, we have been trying to move money away from that type of investment, not in a lock, stock and barrel basis, but you can’t ignore the fact that mid caps in particular have outperformed massively, so we have been looking for ways to manoeuvre capital towards the larger cap opportunities.”
One of McQuaker’s most recent acquisitions has been the £2.8bn Veritas Global Equity Income fund, which is headed up by the FE Alpha Manager duo of Charles Richardson and Andy Headley.
FE Trustnet recently pointed out that it is the most popular global equity income fund among fund of funds managers.
“A trade which we have done, both at the end of last year and at the beginning of this year, has been out of UK small and mid to buy Veritas Global Equity Income,” McQuaker said.
“That is a big fund that has a lot of exposure to large caps and is quite a concentrated portfolio of 29 holdings. It has not done well over the last couple of years and it has a lot of exposure to areas that are not, in any sense, flavour of the month.”
According to FE Analytics, Veritas Global Equity Income has been the best-performing portfolio in the IMA Global Equity Income sector since its launch in February 2005, with returns of 124.77 per cent, and has comfortably beaten its MSCI World benchmark in the process.
Performance of fund vs sector and index since Feb 2005
Source: FE Analytics
However, due to its returns of just 1.28 per cent over the last 12 months, it has underperformed against its benchmark over rolling one-, three- and five-year periods.
McQuaker (pictured) says that its recent underperformance is its major attraction.
“It is big on oil,” he said. “It has a lot of exposure to companies like Shell, BP and Total and that hasn’t worked to date. However, if there were to be a correction in markets then in those circumstances no one is going to be rushing to sell oil, no one has been buying it for the last couple of years.”
He added: “There is an argument that there is fundamental value to be found in the sector.”
Our data shows that the Veritas fund has a 22 per cent position in energy companies, making it Richardson and Headley’s largest sector weighting. Stocks such as ENI and Statoil feature in their list of top-10 holdings.
The fund – which has a running yield of 4.4 per cent – is primarily geared towards institutional investors, though retail investors can buy it via a number of platforms including Trustnet Direct.
It has a total expense ratio (TER) of 0.89 per cent.
McQuaker is also currently backing the £6.2bn Artemis Income fund, which is run by Adrian Gosden and FE Alpha Manager Adrian Frost, as it gives him core exposure to the UK market and because the managers, in the past, have added value in times of volatility.
“We own Artemis Income, that’s quite a significant core holding for us. I think it makes sense to have exposure to things that have lagged. We have had a phenomenal bull market and there are some opportunities, I mentioned oil, where you don’t need fireworks to generate a decent rate of return.”
“Of course, it has been nice to be exposed to something that has done very well and no one is going to complain about that, but people who are investing for income are often looking for reliability.”
“They want something that will meet the bills and allow them to continue to enjoy their lifestyle and keep their capital intact. I think some of these big, reliable, quality income funds such as Artemis Income are very well placed to do that,” he added.
Artemis Income is a top-quartile performer in the IMA UK Equity Income sector over 10 years with returns of 153.59 per cent.
It has beaten its benchmark – the FTSE All Share – by close to 25 percentage points.
Performance of fund vs sector and index over 10yrs
Source: FE Analytics
It has also comfortably beaten the sector and the index over seven years.
However, it has largely underperformed since the financial crash in 2008, which can mainly be attributed to the managers’ heavy weighting to large and often defensive companies.
Nevertheless, it was a top-quartile performer in the falling markets of 2007 and 2008 and managed to return 0.07 per cent in 2011, while the average fund in the sector lost money.
Artemis Income has a yield of 3.83 per cent. Frost and Gosden count the likes of HSBC, BP, GlaxoSmithKline and Vodafone as top-10 holdings.
The fund has an ongoing charges figure (OCF) of 0.79 per cent.
McQuaker has been managing funds in the IMA universe since January 2005 and currently heads up the Henderson Multi Manager Diversified, Managed, Active, Income & Growth and Distribution funds.
McQuaker has returned 63.7 per cent to his investors during his time running IMA funds compared with 37.95 per cent from his peer group composite.