Small CapsAug 21 2017

Fund Review: Investors miss UK small cap referendum recovery

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Fund Review: Investors miss UK small cap referendum recovery

The IA UK Smaller Companies sector has had a year of excellent returns, but investors have not taken full advantage

The group saw a sell-off just after the UK voted to leave the EU in June 2016, and for the following few months suffered as investors turned towards the FTSE 100, aiming to benefit from thre growing value of foreign revenues as sterling depreciated.

The average fund in the sector fell by 10 per cent between June 23 and 28, before recovering. It wasn’t until April 2017 that returns from the peer group exceeded the gains made by the FTSE 100 index. It is now roughly 4 per cent ahead.

Those who bought near the lows have seen excellent returns, with the sector up around 45 per cent since June 28 compared with the average of 29 per cent from UK All Companies peers and a 25 per cent rise in the FTSE 100. 

It is unfair to expect investors to time the bottom of the market to the day, but data shows they have not recognised the rally and missed out as a result. 

Despite the sector returning an average of 27 per cent in the 11 months to the end of June, the sector suffered outflows of £341m, with investors reducing exposure despite a strong bull market.

One reason for the strong showing of UK smaller-company funds has been the performance of the market, with the Numis Smaller Companies + Aim ex ITs index, which most closely represents the average manager’s investment universe, up 23 per cent. 

The UK economy has been doing better than most economists forecast it would do in the event of a Leave vote. 

Another factor is that investors have overestimated the exposure of the UK smaller-companies market to domestic revenues. Only 55 per cent of revenues of the companies in their MSCI UK Small Cap index come from the UK, with 13 per cent from the EU and 32 per cent elsewhere, according to MSCI. 

Some UK small caps are entirely domestically focused, but others are very international, such as Games Workshop, which saw a 21 per cent increase in revenues this year on a constant currency basis boosted to a 34 per cent rise due to the depreciation of sterling. 

Oxford Instruments saw a 3.7 per cent fall in constant currency revenue turn into a 9 per cent increase. Tonic maker Fever-Tree, one of the stars of recent years, now generates just 41 per cent of its revenues from the UK and had 7 per cent added to 70 per cent revenue growth in the first half of this year as a result of the currency.

The largest stocks on the Alternative Investment Market (Aim) have been driving returns and helping active funds to outperform. The Aim 100 is up 40 per cent in the past year. This includes some stocks large enough to be included in the FTSE 250, such as Asos, Boohoo and Fever-Tree, all of which are international businesses that are growing foreign currency revenues.

Thomas McMahon is a senior portfolio analyst at FE

The Picks:

Old Mutual UK Smaller Companies Focus

Nick Williamson took over this £272m strategy at the beginning of 2016, in his first fund management role after being an analyst at Citigroup. Although Mr Williamson has only run money for a short period, it has been a successful tenure. Since January 2016 the fund has returned 76 per cent, versus the 29 per cent increase for the Numis Smaller Companies + Aim ex ITs benchmark and the IA UK Smaller Companies sector. The manager favours popular names such as Boohoo and Fever-Tree, but also holds 40 per cent in financials and industrials. 

Invesco Perpetual UK Smaller Companies IT

Jonathan Brown has managed this £163m trust since 2002 and was joined by Robin West as he returned to Invesco Perpetual from Aviva Investors in 2014. Mr Brown had already overseen a strong five-year performance of 15 percentage points above the sector average, and maintained first-quartile performance over one and three years, alongside Mr West. The share price has increased 58 per cent over three years. The duo favour industrials, which take up a third of the fund, with zip manufacturer Coats the largest holding.  

Editor's Pick:

Henderson Smaller Companies IT

This £595m investment trust has been managed by Henderson head of UK smaller companies Neil Hermon since 2002. The fund is first quartile over three and five years, returning 189 per cent since August 2012 versus a 92 per cent increase for the Numis benchmark. Share price returns have been 60 and 151 per cent respectively over three and five years. The manager had fallen to second quartile across one year, but remains ahead of both sector and benchmark. Mr Hermon also backs industrials, with 38 per cent of the fund in the sector.