UK large caps’ market leadership following the EU referendum has failed to persuade Legal & General UK Special Situations Trust manager Richard Penny to overhaul his market cap weightings, as he argues trends such as sterling weakness are unlikely to persist indefinitely.
Small- and mid-cap stocks have been a popular source of returns among UK equity investors in recent years. However, since the EU referendum, which drove down the value of sterling as well as prompting concerns about the UK’s domestic economy, the FTSE 100 has outperformed its 250 counterpart by 10 percentage points.
While the FTSE 250 has recovered from an initial post-referendum fall and gained 7.1 per cent in sterling terms since June 23, according to FE Analytics, the large-cap FTSE 100 has overshadowed this with a 17.6 per cent return.
However, Mr Penny, who has half of his fund in smaller names, believes factors such as a future recovery in sterling could threaten the current dominance of large caps, strengthening the case for smaller holdings.
“We have half [the fund] in mid and small caps,” he said. “Are we going to change that? Will we see 10 years of large-cap outperformance? I don’t think so.
“Sterling is looking undervalued by some metrics [but] it doesn’t mean it’s going to jump back soon. It’s not going to go on for years and years.”
But Mr Penny is purely focusing on smaller names, with companies such as top-10 holding Royal Dutch Shell at the centre of his recent deliberations.
The manager has considered whether an alternative could be found as he believed the oil giant – which represented 4.2 per cent of the fund at the end of November – faced headwinds.
“We have done pretty well in [Shell] and we are looking at that,” he said. “I don’t see the oil price going up massively but I wouldn’t want to be much more underweight [oil and gas]. There might be a good reason to switch from Shell into something else.
“With Shell, the oil price needs to go slightly higher for it to pay its dividend. I think it will sell assets to pay that.”
Oil and gas holdings made up 7.2 per cent of the fund at the end of November, while a number of sectors had more significant weightings, such as healthcare’s 15.3 per cent.
Within this space, Mr Penny has been adding to a holding in British-based pharmaceuticals company Vectura, which focuses on developing inhalation products.
“It has a new product that’s due for launch in the next 18 months, and it has a partnership with Novartis,” Mr Penny said. “At the moment, we are paying for the existing drugs and not the future drugs. There’s scope for some good upside in 2017.”
The manager also initiated a number of positions last year, including a holding in Regis Group, which invests in the UK private rented sector among other activities, and Gym Group.
Meanwhile, trends such as possible disruption in areas like online gaming have captured his attention.
“We are looking for areas that are growing for all that it’s a low-growth environment,” he explained. “There are some disruptive things going on in relation to mobile games and the internet.”
According to FE Analytics, the fund has delivered a 23 per cent return over three years, compared with 18 per cent from its IA UK All Companies peer group.
