Franklin UK Smaller Companies, Liontrust Special Situations and the Aurora investment trust are three funds that could thrive in today’s uncertain economic environment, according to investment professionals.
This follows an FE Trustnet article published last Thursday, which considered whether UK small- and mid-caps could be set to perform well now that yields have started to rise.
Performance of index in 2017
Source: FE Analytics
Indeed, research by FE Trustnet showed that, over the course of the last decade, gilt yields have finished the year higher than they started during 2009, 2013 and 2015. During each of these time frames, the IA UK Smaller Companies sector significantly outperformed the IA UK All Companies and IA UK Equity Income sectors.
While smaller, domestic-facing companies have thrived once again this year, Tilney Group’s Jason Hollands and Charles Stanley Direct’s Rob Morgan said there are likely to be other drivers at play.
“While this is the likely explanation for the correlation in the course of normal economic cycles, you shouldn’t necessarily expect it to always be the case,” Morgan said.
“I don’t actually think this is the case at the moment though and UK smaller companies do look reasonable value as a lot of people have written off the UK economy unfairly as a result of concerns over Brexit. I’m also not convinced interest rates, and gilt yields, will rise that much.”
Given uncertainty surrounding ongoing Brexit negotiations and the volatility of sterling, we asked Morgan, Hollands and Downing’s Neil Shillito to choose a UK equity fund which they believe will stand investors in good stead. Their choices are explained in the below article:
Morgan said a well-rounded small companies fund such as Franklin UK Smaller Companies could continue to do well in today’s challenging environment.
“It’s a stockpicking fund with a good balance of smaller companies across various sectors and type,” he explained. “It is concentrated – meaning it has a relatively small number of holdings – which increases the impact of each holding on performance and can lead to meaningful sector-beating returns if the managers get their stock selection right.
“In addition, the fund still benefits from its small size, which allows it to invest flexibly across the range of opportunities presented.”
Headed up by Richard Bullas and FE Alpha Manager Paul Spencer, the fund will invest in companies that are between £100m and £1bn in size.
When selecting these stocks, the team first analyses the backdrop a top-down perspective and then selects individual companies within the sectors they expect to do well.
Bottom-up fundamentals the managers focus their attention on include the strength of management teams, balance sheet health and business risk. Examples of its largest individual holdings include photonics technology specialist Gooch & Housego, business management consultant Restore and retail logistics provider Clipper Logistics.
Over five years, the £270m fund has outperformed its average peer and benchmark by 24.02 and 34.36 percentage points respectively with a total return of 134.15 per cent.
Performance of fund vs sector and benchmark over 5yrs
Source: FE Analytics
It has done so with a bottom-quartile annualised volatility, maximum drawdown (which measures risk-adjusted returns) and downside risk (which predicts a fund’s susceptibility to lose money during falling markets) relative to its average peer, suggesting the fund may not be best suited to the more cautious investor.
Franklin UK Smaller Companies has a clean ongoing charges figure (OCF) of 0.83 per cent and yields 1.11 per cent.
Hollands’ pick for today’s backdrop is Liontrust Special Situations, which is able to invest across the whole of the market cap spectrum.
Headed up by FE Alpha Manager duo Anthony Cross and Julian Fosh, the £2.9bn fund has returned 84.74 per cent over five years compared to its average peer and benchmark’s respective returns of 66.47 and 60.05 per cent. It has done so with a top-quartile annualised volatility, maximum drawdown and downside risk ratio.
Hollands said: “[The fund] has a clearly defined strategy of identifying companies with durable competitive advantages that can keep delivering growth throughout the economic cycles.
“These might include ownership of intellectual property, access to distribution networks that potential competitors cannot easily replicate or a high proportion of recurring revenues under contracts.
“At a time of uncertainty I feel this process will prove very resilient.”
The five FE Crown-rated fund currently has a portfolio of 49 stocks, with Diageo, Unilever and RELX Group accounting for some of its largest individual holdings.
In terms of its cap size allocation, Liontrust Special Situations currently holds 41.6 per cent in FTSE 100 stocks, 30.8 per cent in UK mid-caps and 16.4 per cent in FTSE AIM constituents.
It has a clean OCF of 0.87 per cent and yields 1.84 per cent.
Over on the closed-ended side, Downing’s Neil Shillito said Gary Channon’s Aurora investment trust would present a good option for investors looking to gain exposure to the UK market.
“Because pretty much everything in our world is ultimately connected to the ‘risk-free rate’ (personally I’ve always thought that government bonds were anything but ‘risk-free’), we are now in a ridiculous position where a zero rate of return measured against inflation is a good call,” he pointed out.
“So, what’s the answer? Well, conventional equities should be a better bet, but the market is affected by fixed interest and inflation as is everything else.
“To my mind, investors should have some allocation to more ‘activist’ or perhaps more appropriately ‘aligned’ funds where the return comes not from the asset class per se, but from identifying ‘good’ stocks through painstaking research and patience, that are generally badly mispriced.”
The Aurora investment trust, which is £73m in size, aims to provide capital growth through a highly-concentrated portfolio of ‘deep value’ stocks.
For instance, its largest individual weighting is Lloyds Banking Group at 10.2 per cent, followed by Bellway at 9.2 per cent and Sports Direct at 9.1 per cent. Other notable positions in the portfolio include Tesco, Morrisons and JD Wetherspoons. The trust currently has a 14.5 per cent cash weighting.
Over five years, the trust has returned 55.14 per cent compared to its average peer and benchmark’s respective returns of 77.44 and 60.05 per cent. It has done so with a top-quartile annualised volatility, maximum drawdown and downside risk ratio.
Performance of trust vs sector and benchmark over 5yrs
Source: FE Analytics
The Aurora investment trust is trading on a 2.3 per cent premium and yields 1 per cent.