A sluggish economy has historically meant bad news for smaller companies as they are more sensitive to domestic growth. But now the UK is starting to pick up again and, with a new governor in charge of the Bank of England (BoE), the UK’s economic outlook could be improving.
The rate of the consumer price index (CPI) inflation fell to 2.8 per cent in July from 2.9 per cent the preceding month. The retail price index (RPI) also fell from 3.1 per cent to 3.3 per cent in June. According to the Office for National Statistics (ONS), house prices saw a year-on-year increase of 3.1 per cent in June compared with a 2.9 per cent rise in May.
Forward guidance
More recently, the BoE warned in August that inflation will remain high for longer than it had previously expected, and growth levels will be weaker for longer. The new governor, Mark Carney, announced in the Bank’s quarterly inflation report that inflation is likely to remain at more than 2 per cent for at least another year – roughly six months longer than was forecast in February’s report. Mr Carney also said the Bank will not raise interest rates until UK unemployment has fallen to 7 per cent or less – it is currently 7.8 per cent. He admitted it could take up to three years.
Mr Carney said the Bank will not cut back on its current £375bn quantitative easing programme. The move is similar to that of the European Central Bank and the US Federal Reserve in what is known as “forward guidance” interest rate policies.
Beyond the UK, smaller companies based here have become increasingly global. A reliance on international revenue streams means they are perhaps not as volatile as once considered.
According to the latest figures from the Investment Management Association (IMA), UK funds were the bestsellers with net retail sales of £479m, the highest figure since October 2006. The month’s sales were also well above the £60m outflows that the funds averaged over the previous 12 months.
June represented the first time since May 2012 that global equity funds have been beaten as the top-sellers, suggesting the UK is back on track. In terms of quarterly net retail sales, UK equity funds secured £857 million for Q2 2013, again the highest it has been since Q4 2006.
Aim small
So how have the UK’s smaller companies funds been faring? To qualify for inclusion in the sector, the IMA says funds must invest at least 80 per cent of their assets in UK equities of companies which form the bottom 10 per cent by market capitalisation.
The government recently decided that investors should now be able to allow Aim shares in their Isas. Aim shares are typically small- and medium-sized companies that are not ready to list on the FTSE, but there are some companies which fall under the smaller company label that are already well-known household names. Majestic Wine, designer Mulberry and online retailer ASOS are just a few of the brands in which individuals could potentially invest.
But for investors who would prefer to invest in the companies through a fund, there is the UK Smaller Companies sector. It is relatively small, with just 55 funds (UK All Companies houses 274).
Table 1 shows the top 10 performing unit trusts and investment trusts ranked over five years. The Table shows cumulative performance based on an initial £1,000 investment over one, three, five and 10 years as at 1 August 2013 with net income reinvested. The top performing fund of the IMA sector is the £346m Fidelity UK Smaller Companies fund, managed by Alex Wright.
The investment trust performance is from the Association of Investment Companies (AIC) UK Smaller Companies sector. The top performing closed-ended fund is Harry Nimmo’s Standard Life UK Smaller Companies trust.
Both the Fidelity fund and Standard Life trust have very similar asset allocation weightings. According to Morningstar data, Fidelity’s fund holds 39.8 per cent in cyclical stocks – Standard Life holds 42 per cent.
One fund that stands out is the Marlborough UK Micro Cap Growth fund, managed by Giles Hargreave. The fund is the fourth top performer over five years based on an initial £1,000 investment. It invests predominantly – more than 86 per cent of the fund – in ‘micro-cap’ funds which are classified as having a market capitalisation of less than £250m. The highest sector allocation is technology at 32 per cent, followed by industrials at 21 per cent.
It is easy to overlook the UK Smaller Companies space, but it has actually been one of the most stable with regards to net retail sales of all equity sectors.
The IMA UK Smaller Companies sector has seen positive flows into the space since September 2012. Unlike its All Companies counterpart, which saw outflows from May 2012-May 2013. In June there were inflows of £56m, up from May’s figures of £44m, proving that UK Smaller Companies are still popular with investors. UK Smaller Companies also dominated top performing funds available for Isas towards the end of last year’s Isa season. And the UK Smaller Companies sectors aren’t showing any sign of slowing down. In fact, no fund or investment trust failed to return on its initial investment over five years.
Five questions to ask
1. Are you suited to small- or large-cap funds? Be prepared that smaller companies tend to carry more risk and volatility than large-caps. The FTSE Small-Cap index saw similar losses in 2008 to the FTSE 100, but small-caps have had a less volatile recovery.
2. How global is the fund? Many UK smaller company funds are now very global. They invest heavily in companies with a large global presence. If you want a largely UK-based fund, look into the fund’s allocation.
3. What is the management fee? Always check what the management fee or initial charge will be on a fund. It may be that an investment trust with a similar strategy and asset allocation may work out cheaper for your client.
4. Could you do it yourself? Now Aim shares are available on Isas, look to see if it is possible to create your own portfolio using shares instead of funds. It may bypass some management fees.
5. What is the fund’s strategy? While it is a small sector, there are diverse options. It is important to look into these before investing to find the best match for you or your client.
