Liontrust UK Smaller Companies, Marlborough UK Micro Cap Growth and Montanaro UK Income are among the best funds for investors looking for exposure to Brexit-proof UK small-cap stocks, according to fund pickers.
Last week, FE Trustnet looked at whether backing small-caps in the current climate – with Brexit uncertainty overhanging the UK market – was a good idea.
Gary Waite, manager on the Walker Crips Alpha r² model portfolio range, said investors are right to remain cautious of the sector and as a rule of thumb for UK funds, the smaller the market cap the more exposed to a ‘hard’ Brexit they'll be.
“Firms that generate revenue largely in the UK but have to import goods and services from the EU and elsewhere will bear the brunt of downward pressure on sterling and increasing levels of tariffs and red tape,” he said.
However, analysts concluded that by backing smaller, growth companies in sectors such as technology and healthcare that have the propensity to outperform regardless of the UK economy makes sound investment logic.
Below, we ask fund pickers for their preferred vehicles to play the UK smaller companies space.
Liontrust UK Smaller Companies
First up is the five FE Crown-rated Liontrust UK Smaller Companies run by FE Alpha Managers Anthony Cross and Julian Fosh since 2008, with Victoria Stevens and Matthew Tonge joining the pair in 2015.
Walker Crips’ Waite said: “Within our model portfolios we hold the Liontrust UK Smaller Companies fund which has been a consistent performer over time, and encouragingly, when volatility increases it has tended to outperform its peer group.”
He added that while it is natural to expect elevated levels of risk in UK small-cap sector in the event of a hard Brexit, the Liontrust management team’s focus on high-quality companies with strong barriers to entry such as comprehensive intellectual property rights covering their core business should help to insulate it.
“Investors who have a longer-term horizon could benefit from taking a buy and hold position in a high-quality fund with a view to riding out the storm,” he said.
The fund has been a top quartile performer in the IA UK Smaller Companies sector over three, five and 10 years, returning 442.76 per cent over the last decade.
Performance of fund vs sector and benchmark over 10yrs
Source: FE Analytics
Over the period, the fund has indeed also been the least volatile (11.46 per cent) in the sector and has the lowest maximum drawdown – the most an investor could have lost if buying and selling at the worst possible times.
Andy O’Shea, head of investments at Pharon Independent Financial Advisers, also chose the fund as his choice, highlighting the team’s proprietary Economic Advantage process.
“For inclusion in the fund, companies must be able to demonstrate competitive advantage through their trading record, be attractively priced and at least 3 per cent of the equity must be held by the directors,” he said.
“The team’s focus on quality, but not irrespective of price has provided investors with a good level of long-term capital growth.”
He added that other factors including the fund’s maximum drawdown and Sortino ratio – which measures the ‘right’ types of volatility – are the main reasons to consider it.
“If you are looking for a safe, dependable team to manage your money through the Brexit uncertainty look no further,” O’Shea said.
The £926m fund has a clean ongoing charges figure (OCF) of 1.36 per cent.
Marlborough UK Micro Cap Growth
Darius McDermott, managing director at Chelsea Financial Services, said that his preferred selection is the £1.2bn Marlborough UK Micro Cap Growth fund run by FE Alpha Manager Giles Hargreave and Guy Feld.
"In our view, this is one of the stand-out funds in the IA UK Smaller Companies sector,” McDermott explained. “Co-manager Giles Hargreave has been running funds for more than 40 years, while fellow co-manager Guy Feld has more than 25 years' experience of researching small- and mid-cap equities.
“Both managers have exemplary track records in their own right and, by pooling their ideas together, they have created a fund which has comfortably beaten its average peer since launch.”
Over the past decade the fund has returned 425.75 per cent, beating the average sector peer by 189.29 percentage points.
Performance of fund vs sector and benchmark over 10yrs
Source: FE Analytics
It is another that has strong other statistics as well, with top quartile volatility, maximum drawdown and Sortino ratios.
The fund is a diversified portfolio of around 250 stocks, which minimises company-specific risk and limits volatility.
Very small positions in each company are taken at first, and these are gradually added to as their stories unfold.
“Giles and Guy first take a view on the wider economy to filter out large numbers of companies and sectors, then they undertake extensive company analysis and meet management teams,” McDermott noted.
Currently, the fund is most heavily-weighted to industrials stocks, with technology, consumer services and financials also double-digit sector positions in the portfolio.
Marlborough UK Micro Cap Growth has an OCF of 0.79 per cent.
Montanaro UK Income
Last up is the Montanaro UK Income fund, which sits in the IA UK All Companies sector and is benchmarked against the IA UK Equity Income sector.
The £306m portfolio has been overseen since 2012 by Charles Montanaro, having previously run it between 2006-2011.
The fund is focused on both the mid- and small-cap space, with 46 per cent invested in companies with a market capitalisation of £1bn or under and 53 per cent in stocks worth between £1bn and £10bn.
“We really like Montanaro as an investment house, they are genuinely long-term investors, once they identify a suitable company, their ideal holding period is ‘forever’,” Ryan Paterson research manager at Thesis Asset Management said.
“They invest only in the highest quality, well-managed businesses operating in growth markets.”
The fund has been a top-quartile performer over the last 10 years returning 230.57 per cent and beating both sectors, as the below chart shows.
Performance of fund vs sectors over 10yrs
Source: FE Analytics
More recently, the fund has delivered a total return of 36 per cent over the past three years to June 2018, which compares to 24 per cent for the average income fund.
This has been driven by particularly strong individual performances within financials (Big Yellow and Hiscox); consumer goods (Cranswick and Hilton Food); and industrials (Ashtead and Marshalls).
“Investors get the best of both worlds from the Montanaro UK Income Fund, which focuses exclusively on small- and mid-caps,” Paterson said.
“They receive higher capital growth from the small-cap effect and an attractive yield with higher dividend growth from the mid-caps. These companies tend to be less well-researched and over-looked, so they can offer attractive returns.”
Montanaro UK Income has a yield of 3.4 per cent and an OCF of 0.85 per cent.