Fund briefing: UK smaller companies
Over the past year, the average portfolio focused on these areas has enjoyed bumper double-digit returns, with some up more than 30%, according to Morningstar data to 31 October 2015.
The success enjoyed by IA UK Smaller Companies and IA European Smaller Companies contrasts with sectors such as Asia Pacific excluding Japan and Global Emerging Markets, in which many investors have lost substantial amounts of money.
Darius McDermott, managing director of Chelsea Financial Services, attributes the strong performance to a number of factors, with UK-focused funds benefiting from a domestic focus at a time when our economy has been stronger than many around the world.
“There are also fewer commodities companies in the smaller companies space – and these have been hit very hard recently, as well as some larger companies with emerging market exposure,” he says. “Not investing in these companies has helped performance.”
To be included in the IA UK Smaller Companies sector, funds must invest at least 80% of their assets in UK equities of companies forming the bottom 10% by market capitalisation.The North American and European Smaller Companies sectors have similar requirements.
Financial advisers regularly use such funds when they are putting together overall portfolios for their clients. Alex Bland, investment manager at Beacon Wealth Management, is one who favours the sector.
“We like to complement our overall UK equity exposure with small caps,” he says. “They tend to provide a good return for reasonably low volatility and always tend to be the first to benefit from any uptick in market trends or recovery cycle.”
There are two main reasons for considering an investment in one of these sectors, according to Justin Modray, founder of Candid Financial Advice: diversification and the fact that they tend to enjoy better longer- term returns.
“It’s quite common for UK investors to own tracker funds that follow indices such as the FTSE 100 in their overall portfolio,” he says. “These give them a very high bias towards larger companies, many of which are in a handful of sectors, such as energy and mining.”
Such areas may not always be attractive propositions, he argues, which is why it can make sense for most balanced investors to have at least some exposure to smaller companies in order to hedge out this larger company exposure.
“The caveat is that smaller companies tend to be more volatile,” he adds. “When things do well, you might make more money but if markets fall, you tend to find smaller companies can go down further, so it’s important not to put too much in if you’re afraid of taking a risk.”
So why do smaller companies offer more potential? According to Mark Dampier, head of research at Hargreaves Lansdown, the fact these stocks are only followed by a few analysts presents opportunities for skilled fund managers to spot opportunities.
“Unlike larger companies such as Tesco or Vodafone, which might have dozens of analysts poring over their accounts, smaller companies tend to be under-researched,” he explains.
“Some will blossom into the giants of tomorrow, but others will struggle or fail altogether.”
Therefore, selecting the winners from the UK’s ever-expanding pool of smaller companies is not easy, which means relatively few fund managers can be relied upon to deliver consistently strong returns.
It’s also worth noting that not all smaller companies funds are the same – some invest right down the scale in micro-caps, while others look at the bigger smaller companies and smaller medium-sized companies.
The key when you’re selecting a smaller companies fund manager is deciding if they have experience and a proven track record of success in different environments, according to Patrick Connolly, a certified financial planner with financial adviser Chase de Vere.
“You need managers who can really get under the skin of companies to understand how they work and assess their future plans and prospects,’” he said. “The best can uncover fantastic companies with great growth prospects that have been overlooked by others.”
Of course, the amount you should invest in such funds depends how much exposure you already have, as most people will have some investments in this area by virtue of the broad-based equity funds they own, points out Connolly.
“If that’s the case, many investors won’t necessarily need any further investments in smaller companies funds,” he said. “If they want specific smaller company exposure, then it probably makes sense to start with UK smaller companies, although other parts of the world also still have strong growth potential.”
Fund to watch: Schroder Dynamic UK Smaller Companies
A relative handful of UK smaller companies funds make it into Hargreaves Lansdown’s coveted Wealth 150 list of favoured portfolios but one that has is Schroder Dynamic UK Smaller Companies, run by Paul Marriage and John Warren.
Mark Dampier, head of research at Hargreaves Lansdown, says the fund was selected because the management team boasted plenty of experience, a disciplined approach to investing, and a history of outperformance.
“We have long been supporters of the higher-risk UK smaller company space and the sector contains many high calibre individuals,” he says. “The managers remain incentivised to perform and we believe they are capable of driving long-term growth.”
The fund, which aims to provide capital growth, will have at least 80% invested in shares of UK companies that are in the bottom 10% of the UK stockmarket at the time the fund purchases them. It doesn’t have any bias to particular industries.
At present, industrials is the sector with the largest share of assets (39.3%), followed by consumer goods (13%), technology (12.4%) and consumer services (12.2%). Other sectors represented, each of which have a share of less than 10%, include financials
The fund’s 10 largest holdings account for 32.6% of its assets and include names such as logistics company Wincanton; Johnson Service Group, which supplies textile related services; and Treatt, a supplier of flavour and fragrance ingredients.
A way of valuing a company by the total value of its issued shares and calculated by multiplying the number of shares in issues by the market price. This means the market capitalisation fluctuates continually as the value of the shares change in the market. For example, HSBC has 17.82bn shares in issue at a price of 646.2p making a market capitalisation of £115.15bn.
Also known as index funds, tracker funds replicate the performance of a stockmarket index (such as the FTSE All Share Index) so they go up when the index goes up and down when it goes down. They can never return more than the index they track, but nor will they lose more than the index. Also, with no fund manager or expansive research and analysis to pay, tracker funds benefit from having lower charges than actively managed funds, with no initial charge and an annual charge of 0.5%.
An individual employed by an institution to manage an investment fund (unit trust, investment trust, pension fund or hedge fund) to meet pre-determined objectives (usually to generate capital growth or maximise income) in prescribed geographic areas or investment sectors (such as UK smaller companies, technology or commodities). The manager also carries the responsibility for general fund supervision, as well as monitoring the daily trading activity and also developing investment strategies to manage the risk profile of the fund.
A market-weighted index of the 100 biggest companies by market capitalisation listed on the London Stock Exchange. It is often referred to as “The Footsie”. The index began on 3 January 1984 with a base level of 1000; the highest value reached to date is 6950.6, on 30 December 1999. The index is “weighted” by how the movements of each of the 100 constituents affect the index, so larger companies make more of a difference to the index than smaller ones. To ensure it is a true and accurate representation of the most highly capitalised companies in the UK, just like football’s Premier League, every three months the FTSE 100 “relegates” the bottom three companies in the 100 whose market capitalisation has fallen and “promotes” to the index the three companies whose market capitalisation has grown sufficiently to warrant inclusion. Around 80% of the companies listed on the London Stock Exchange are included in the FTSE 100.
Generic, loosely-defined term for markets in a newly industrialised or Third World country that is in the process of moving from a closed economy to an open market economy while building accountability within the system. The World Bank recognises 28 countries as emerging markets, including Argentina, Brazil, China, Czech Republic, Egypt, India, Israel, Morocco, Russia and Venezuela. Because these countries carry additional political, economic and currency risks, investors in emerging markets should accept volatile returns. There is potential to make large profit at the risk of large losses.
An interchangeable term for shares (UK) or stocks (US). Holders of equity shares in a company are entitled to the earnings and assets of a company after all the prior charges and demands on the company’s capital (chiefly its debts and liabilities) have been settled. To have equity in any asset is to own a piece of it, so holders of shares in a company effectively own a piece proportionate to the number of shares they hold. (See also Shares).
A term applied to raw materials (gold, oil) and foodstuffs (wheat, pork bellies) traded on exchanges throughout the world. Since no one really wants to transport all those heavy materials, what is actually traded are commodities futures contracts or options. These are agreements to buy or sell at an agreed price on a specific date. Because commodity prices are volatile, investing in futures is certainly not for the casual investor.