Investing in UK Smaller Companies
Investing in UK Smaller Companies

UK Smaller Company Funds

What is the attraction?

Date of publication - September 2018

Author - Stephen Luwero

The aim of any active fund manager is to deliver returns in excess of the market but not all manage this feat. This can be particularly difficult for those that are focused on larger companies in the UK where choice can be narrow and is restricted to FTSE 100 listed companies. However, for those managers that ply their trade dealing in smaller companies the choice is much broader and historically has proven very lucrative.

Over the past 10 years to the 31st July 2018, the UK smaller companies sector has returned more than any other UK sector for its investors. It has delivered 2801.1% (with income reinvested) compared to 142.6% from the UK All Companies sector, making it the sixth best performer of the Investment Association's 38 sectors. This extends to the medium term too, with UK smaller companies delivering more than any other UK sector over three and five years (source: Money Observer).

UK smaller companies benefit from lower valuations,stronger growth and ability to adapt quickly to changes in a buoyant domestic market. The sector can be subject to high levels of volatility however, driven by localised events (such as BREXIT) but despite this it remains resilient offering attractive investment opportunities.

How the BREXIT referendum result impacted on smaller company funds.

Prior to the vote in June 2016, the UK economy had been making steady progress following the financial crisis that began in 2008. The FTSE All-Share index was a particular beneficiary thanks to loose monetary policies (including historically low interest rate) and Quantitative Easing (creating new money electronically by the Bank of England to make large asset purchases).

When David Cameron announced the date of the BREXIT vote following the Conservative party's return to power, financial markets and institutions did not expect the result to turn out he way it did. It was generally expected that the UK population would vote to remain in the European Union and the fact that it did not came as a huge surprise to most. 

EU and UK

The immediate reaction was a fall in sterling which for a number of months boosted the share prices of larger companies such as BP and Unilever. With a large proportion of their earnings being generated overseas, the lower value of the pound artificially increased profits when the earnings were converted back into sterling making them more attractive to investors.

The majority of UK smaller companies however, are more domestically focused than their medium and larger sized counterparts. With a limited currency boost available, the sector as a whole suffered a decline popularity for a number of months.

Sterling decline exaggerated?

Following the BREXIT result, markets and institutions remained in a state of shock however, it soon became clear that the fall in the value of sterling had been overcooked. The economic updates provided by the Bank of England showed that the UK economy had not fallen off a cliff edge as had been predicted and in fact was holding up very well supported by strong consumer spending. Further positive news in the following months helped improve the sentiment surrounding the currency with a further boost provided by the Government and their evolving negotiating stance with the European Union. The potential for a "softer" BREXIT agreement has assisted the rise of the pound from the lows we saw in late 2016.

There remain choppy water ahead however. Not only do we have the uncertainty surrounding BREXIT but concerns over inflation remain with the recent increase in interest rates to 0.75% being the result. The value of sterling tends to rise (historically) when interest rates are increased and this would normally impact on the larger constituents of the FTSE 100 index with much of their revenue being generated overseas. 

The initial uncertainties surrounding BREXIT have been diminishing which has seen a return in popularity of smaller companies for investors where earnings are more directly correlated with the UK domestic market and, arguably, more predictable.

Taking advantage of he opportunities in the UK Smaller Companies sector.

The UK smaller companies sector is a true "stockpickers" market where the skill of a fund manager in identifying firms that have the potential to grow and thrive needs to be at its most honed. According to FE Trustnet, for example, the UK Smaller Companies sector has more Alpha rated managers (those that consistently beat their benchmarks) than in any other sector. A third of UK Smaller Company fund managers have achieved this title compared to just 4% of Global Equity Income managers.

There some interesting options for investors to consider in this sector. Please contact us for further details.

The information in this article was accurate at the date of publication in September 2018.