EquitiesDec 2 2013

UK small caps enjoy a stellar run

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Small caps have enjoyed a stellar run of late, both in absolute and relative terms and, with hopes pinned on more gains to come, multi-managers are continuing to hold their nerve.

The average UK Smaller Companies fund has soared by 36 per cent in the past 12 months – comfortably outpacing the mean return from the UK All-Companies sector of 27 per cent.

An obvious concern on the back of the strong run is for how long can the pace be maintained, especially when many company earnings have disappointed.

James de Bunsen, manager of the Henderson Multi Manager Income & Growth fund, says: “Small caps are by no means cheap relative to their own history, but a similarly lacklustre earnings story in large caps means that the relative valuation has not meaningfully changed. If the valuation story is mixed then so too are the fundamentals.

“The UK economy is one of the few developed markets to be experiencing meaningfully positive momentum and, given that small caps tend to have a domestic and cyclical bias, this is positive for small caps.”

He is backing the Paul Marriage and John Warren-run Cazenove UK Smaller Companies fund, which has returned 48 per cent in the past year. Mr de Bunsen says: “Not only are the pair talented stockpickers, but they are very strong on risk management, honed from also running a small-cap long/short strategy for many years. This blend has led to consistently strong outperformance.”

Elliot Farley, co-manager of the T. Bailey Growth fund, currently has a bias towards smaller companies in markets across most geographic regions. One of his top picks is Fidelity UK Smaller Companies. Managed by Alex Wright, it is 52 per cent up in 12 months. Mr Farley says: “He has proved himself to be an excellent stockpicker. The fund has soft-closed and he is taking on a significant additional role in also running Fidelity Special Situations, but we rate him very highly.”

Ben Kumar, investment manager at fund-of-fund specialist Seven Investment Management, says within the UK active manager space he rates Old Mutual UK Smaller Companies, which has achieved a 37 per cent return in the past year. “The management team has successfully kept a close eye on the risk of the fund delivering above-average risk-rated performance over the life of the fund. In the passive space, we access the FTSE 250 index through BlackRock Mid Cap UK Equity Tracker fund.”

For his part, JPMorgan’s Fusion fund-of-funds lead manager Tony Lanning believes the growth outlook for the UK remains favourable and has maintained a high-conviction stance in the British economy since his portfolios launched earlier this year. Across the Fusion range he has about 3-5 per cent in small caps, depending on the portfolio.

Previously, he was holding Artemis UK Smaller Companies and Aberforth UK Smaller Companies, but has since sold out of the former. Mr Lanning says: “Both are very good managers. We like the strong value bias of the Aberforth fund – it is a UK Small Cap specialist and its manager Andy Bamford is a very strict value-orientated investor.”

But it is not just in the UK that managers are looking to access the smaller-companies universe. Mr Lanning has investments in the Polar Capital Japan fund. “It has a smaller to mid-cap bias and it has done very well – and is up by circa 43 per cent year-to-date.”

Mr Farley has also looked to Japan, and has access to the market via Baillie Gifford Japanese Smaller Companies fund. He says: “It has performed well and we think it has an effective team approach.”

Seven’s Mr Kumar’s view on small caps recently has been that the UK market has had a very good run in the past couple of years and as a result he has moved underweight UK small caps, preferring instead to look for value in the small- and mid-cap section of the European market, where he uses the iShares Euro Stoxx Mid and the iShares Euro Stoxx Small ETFs.

He says: “Although the small-cap sector has similarly outperformed in Europe, there is still the hangover from the eurozone crisis and we see greater opportunity for smaller firms to grow as the eurozone continues to recover.”

However, Scott Spencer, senior investment manager at Aberdeen Solutions has no pure small-cap exposure, but has a bias to active managers, who tend to find better opportunities down the cap spectrum. He says: “This is especially true in areas like Japan and Asia, given that analyst coverage focuses on the bigger firms.”

Philip Scott is a freelance journalist

SMALL-CAP FUNDS

WHO THE MANAGERS ARE BACKING

James de Bunsen, manager, Henderson Multi Manager Income & Growth fund:

Mr de Bunsen is backing the Cazenove UK Smaller Companies fund managed by Paul Marriage and John Warren. He says: “Not only are the pair talented stockpickers, with a tried and tested investment process, but they are very strong on risk management, honed from also running a small-cap long/short strategy for many years.”

Ben Kumar, investment manager, Seven Investment Management:

The Old Mutual UK Smaller Companies fund is the choice for Mr Kumar, who says: “The management team has successfully kept a close eye on the risk of the fund delivering above average risk-rated performance over the life of the fund. In the passive space, we access the FTSE 250 index through BlackRock Mid Cap UK Equity Tracker fund.”

Tony Lanning, JPMorgan’s Fusion fund-of-funds lead manager:

The pick for Mr Lanning is Aberforth UK Smaller Companies, managed by Andy Bamford. Mr Lanning explains: “We like the strong value bias of the Aberforth fund, they are UK Small Cap specialists and its manager Andy Bamford is very strict value-orientated investor.”