Is now the time to be brave on UK small caps?
This article first appeared in moneymarketing.co.uk on 17th November 2022 Battered by Brexit,...
There are various reasons why so many UK-based equity investors remain enthusiastic about having significant exposure to their home stock market.
For some it’s all about the comfort factor. Many of the companies listed on the London Stock Exchange are familiar names whose products and services they recognise. Others like to feel they’re supporting UK companies, especially smaller firms that have ambitions to grow internationally and compete on the global stage.
Over the years, investors have piled a lot of money into UK equities. There is currently £161.5bn invested in the IA UK All Companies sector, which is for funds investing at least 80% of their assets in UK equities*.
This makes it the second biggest sector behind IA Global’s £169.3bn share, according to the most recent IA data*.
However, there are a number of other sectors that are also UK-focused. The IA UK Equity Income sector has £43.1bn of investors’ cash, while there’s £15.2bn in IA UK smaller companies*.
However, just because a sector has ‘UK’ in the title doesn’t mean to say its fortunes are inextricably linked with our economy or stock market.
In many cases, firms will be listed in London but be exposed to global issues by virtue of the fact they have overseas operations. This is particularly relevant to funds that buy stocks listed on the blue-chip FTSE 100 index which is packed to the brim with international giants.
Generally speaking, smaller companies can be more focused on – and affected by – what goes on in the UK, but that’s not always the case.
Another misconception is that UK focussed sectors are straightforward, and all follow the same broad investing guidelines. However, there certainly isn’t a one-size-fits-all approach.
Let’s take the aforementioned IA UK All Companies sector as an example. While all funds invest at least 80% of their assets in UK equities, management styles may vary enormously.
Some will be focussed on the largest blue-chip names, while others will concentrate their attention on small or mid-cap stocks. Then you have funds that are suitable for those with ethical considerations.
It’s important to make sure the fund – and the manager at the helm – is investing in the areas and style with which you feel most comfortable.
Having hundreds of funds available may provide plenty of choice, but it also makes it very difficult for investors to identify the potential winners – so what’s the answer?
One option is to hand over the selection duties to a professional fund manager that focuses on UK-listed companies and let them make the tough decisions.
Here, we take a look at a number of funds with different ways of focusing on UK-listed companies.
The aim of the fund is to provide capital growth over the long-term – at least five years – by investing in the shares of small-sized UK companies. These are firms that are domiciled, incorporated, or have a significant portion of their business in the UK, as well as a market capitalisation within the bottom 10% of the UK equities market.
The largest stock allocation currently is the 3.8% in Videndum, a global provider of premium branded hardware and software solutions to the growing content creation market**.
This is a fund for investors wanting exposure to the UK’s medium-sized companies. It invests in businesses when they are well established, but still have a long runway of growth potential. These companies will show a range of high-quality characteristics, operate in growing markets, and display positive business momentum.
Bytes Technology Group, a FTSE 250-listed provider of software, security, and cloud services, currently accounts for the largest share of assets under management with a 4.2% share**.
Moving further up the market capitalisation scale, we have a Jupiter UK Alpha. As you would expect, this fund, managed by the experienced Richard Buxton, is packed full of household names, many of which ply their respective trades around the world.
For example, there are pharmaceutical giants AstraZeneca and GlaxoSmithKline; mining and natural resources outfits Glencore and Rio Tinto; and oil majors BP and Shell**. This fund is a high conviction portfolio of 35 to 40, mostly large, UK companies that the manager believes have strong business models, healthy balance sheets and unrecognised potential.
This fund actually sits in the IA Targeted Absolute Return sector, but it invests predominantly in UK equities. It looks to make money not just by investing in good UK firms that it believes with flourish over time, but also by ‘shorting’ the shares of companies it thinks will struggle in the shorter term. This strategy allows the fund to benefit from falling share prices too.
It’s top ten ‘long’ positions currently include AstraZeneca, JD Sports Fashion and Jet2 – these are companies the managers think will do well over time***.
The UK is renowned for its dividend-paying culture and equity income funds make up the core of many a UK investor’s portfolio. This is a concentrated multi-cap income fund with a bias towards smaller companies.
Despite UK smaller companies (and the AIM index in which this fund also invests) struggling more than their larger counterparts this year, this fund is still 5th out of 81 funds in its sector over 3 years***. This is a testament to the manager’s stock picking skills. The current market-cap breakdown is 19% in micro caps, 45.5% in small caps, 9.1% in mid caps and 10.6% in large caps***. The yield on the fund is also an attractive 4.3%.
Manager Alex Savvides believes misunderstanding of corporate change by the stock market regularly presents opportunities for the patient, disciplined and unemotional investor. So, his process aims to profit from understanding this change and investing where there is the highest probability of success but with the highest cash-based valuation support.
Alex has strict investment disciplines: each holding in the portfolio must pay a dividend, and the companies will be well established, in structurally sound markets. He is free to choose across the market cap spectrum, meaning the portfolio can invest in companies of any size and its bias towards any particular market segment will vary over time. Unusually for a fund focusing on capital growth, it produces a naturally good level of dividend yield.
*Source: Investment Association, sector rankings for April 2022
**Source: fund factsheet, 31 May 2022
***Source: fund factsheet, 30 April 2022