Income-focused funds, funds with a value bias and vehicles that invest further down the market cap spectrum are three of the best ways to invest in the UK equity market, according to Hargreaves Lansdown’s Mark Dampier (pictured), who believes the sector is unloved and undervalued. 
The Hargreaves Lansdown research director is relatively positive when it comes to finding new opportunities on home turf, given the negative investor sentiment exacerbated by Brexit-related uncertainty.
However, he warned investors to tread carefully and be selective before buying into funds to hold over the very long term.
“Everyone seems overwhelmingly pessimistic, particularly on the UK with Brexit. But actually, everyone has been pretty pessimistic almost from the bottom of the market in 2009. This has been a really hated bull market and I think the last 18 months have been even more hated as it’s gone up,” Dampier reasoned.
“The thing that makes me slightly more optimistic is that there’s a huge amount of pessimism around.
“Lots of clients are in cash – they’re waiting for something to happen which may or may not manifest itself. We’ve not had a decent correction of 10 to 20 per cent for almost two years and that’s a long time.”
Performance of indices over 2yrs
Source: FE Analytics
As such, the investment veteran believes many investors are sitting on cash and waiting for an overdue correction so they can deploy it. Dampier said this should theoretically mean that markets would recover quickly in the event of a correction.
“The big thing I am looking for is a significant change in interest rates,” he explained. “There are geopolitical events such as North Korea which are really difficult to fathom as well – that could blow a hole in things – but the real factor that normally sets markets off is not just a rise in interest rates but a big change.
“You could maybe see some change with the ending of QE in places. However, central banks are going really slowly so it doesn’t feel like there will be a rapid withdrawal of liquidity. That’s what usually kills the market.”
In the below article, the research director tells FE Trustnet three of the best ways to buy into the unloved UK equity market and which funds he would recommend.
UK small and mid caps
Dampier said: “The small- and mid-cap space is where you’re going to capture your bigger returns in the end. That’s over the course of years and years.
“We’ve been a great fan of Old Mutual’s UK Smaller Companies fund for ages – it has done well over the years and continues to do so now.”
Managed by FE Alpha Manager Daniel Nickols, the four crown-rated fund is £1.2bn in size and aims to provide long-term capital growth through a diversified portfolio of companies further down the cap spectrum.
The portfolio currently consists of 80 holdings, which Nickols selects by combining top-down macro views with detailed analysis of individual companies. Examples of its largest holdings include the likes of Fever-Tree, B2B media company Ascential and online clothing retailer Boohoo.com.
Over five years, the fund has outperformed its average peer and its Numis Smaller Companies (ex IT) index by 52.33 and 62.17 percentage points respectively with a total return of 169.92 per cent.
Performance of fund vs sector and benchmark over 5yrs
Source: FE Analytics
It has done so with a top-quartile Sharpe ratio (which measures risk-adjusted returns) given its significant outperformance.
However, it is in the bottom quartile for its annualised volatility and downside risk (which predicts susceptibility to lose money during falling markets), which suggests it may not be suitable for particularly cautious investors.
Old Mutual UK Smaller Companies has a clean ongoing charges figure (OCF) of 1.03 per cent.
UK value
While there was indeed a snapback in the growth versus value trade during the latter half of last year, this trend appears to have reversed itself year-to-date with the MSCI United Kingdom Growth index more than doubling the return of its value counterpart in 2017, so far.
“There are UK funds that have been having a harder time which are more niche, such as M&G Recovery for example,” Dampier said. “It has actually been performing better recently although it’s behind this year.
“The opportunity to me seems to be in value because it has been out of favour for a long time and the gap is as big as it was back in 2000.
“So, one thing that could happen is – not necessarily a huge market fall – but a significant shift in sentiment. I’m not sure whether I see it as yet, but there is a big gap between growth and value at the moment.”
M&G Recovery has been headed up by Tom Dobell since 2000, who was joined by deputy managers David Williams and Michael Stiasny in 2011.
While the fund performed well for several years, it endured a torrid bout of performance during 2012 to the end of 2015 which has dragged it into the bottom decile over three and five years, as well as into the bottom quartile over the last decade.
That said, Dampier pointed out that value funds have been out of favour for a number of years other than their sudden spike in returns during the last few months of 2016.
Over the last 12 months, M&G Recovery is in the top quartile for its total return of 17.13 per cent compared to its average peer’s return of 13.89 per cent.
Manager Dobell aims to provide growth through companies that he deems to be substantially undervalued by the broader, short-termist market. Each holding within the portfolio is bought with at least a five-year time horizon in mind. Examples of its largest holdings include GW Pharmaceuticals, BP and sewing thread distributer Coats Group.
M&G Recovery has a clean OCF of 0.91 per cent.
UK income
Dampier has long been a fan of UK equity income funds and recently told FE Trustnet why he continues to back star income manager Neil Woodford despite his recent underperformance.
Another fund within the IA UK Equity Income space he likes, however, is Clive Beagles and James Lowen’s £3.3bn JOHCM UK Equity Income fund.
The managers aim to provide both long-term capital and income growth through a relatively concentrated portfolio of between 50 and 70 stocks.
Each of these must prospectively yield more than the FTSE All Share in a bid to prevent the fund holding stocks that are in a bubble; this can often mean the portfolio’s holdings are contrarian relative to the broader market.
Beagles and Lowen also prioritise companies with strong asset backing and will meet the management team of each firm before buying shares. Its largest holdings are currently Shell, HSBC and BP.
Over five years, the fund has returned 85.77 per cent compared to its sector average and FTSE All Share benchmark’s respective returns of 68.86 and 64.10 per cent. It has done so with a top-quartile Sharpe ratio but a bottom-quartile annualised volatility and downside risk ratio.
Performance of fund vs sector and benchmark over 5yrs
Source: FE Analytics
Had an investor placed an initial £10,000 into the fund five years ago, they would have received £2,875.66 in income alone.
JOHCM UK Equity Income has a clean OCF of 0.8 per cent and yields 4.29 per cent.