The case for UK growth and some funds you might put in your Isa

2nd February 2014

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Investment journalist Cherry Reynard gives her assessment of the case for investing in UK Growth along with some broker recommendations below.

When investing in stock markets, most investors will either be hoping to generate an income, or grow their capital. Of course, the two are not mutually exclusive, but some funds prioritise growing capital over paying out a consistent income. This would include funds in the IMA UK All Companies sector, but also funds in the IMA UK Smaller Companies sector. It may also include sector funds, such as those investing in technology.

Range of fund strategies within sector

The UK All Companies sector is perhaps the most diverse of all the sectors. Fund managers have a broad range of views on what causes share prices to grow over the long term. Some believe that it is all about a low price – ‘recovery’ and ‘special situations’ managers will aim to buy companies where the share price is very low. This might be because a company has had a run of bad luck, or negative publicity, or because the sector is out of favour. The manager will buy the company and wait to see if sentiment – and hopefully the share price – improves.

Other managers will aim to find those companies that are generating significant revenue growth. This could be companies supported by a strong secular change, such as online retail, or where a company has a new and innovative product, such as some parts of the technology market.

There will also be funds that specialise in certain types of company. Some managers prefer to invest in smaller and medium-sized companies, believing there is more opportunity for growth. Others prefer to take a more defensive strategy, investing in top-quality blue chips that are less vulnerable to going bust.

Equally, growth managers in the extent to which they include macroeconomic analysis in their selection of companies. Some like to try and time the business cycle, moving into more economically sensitive companies as the business cycle is expanding, or more defensive companies in a recession. Others simply try to pick the best companies and hold them through the cycle.

Funds will also vary in the extent to which they follow an index. Some funds will aim to stick close to their benchmark index – usually the FTSE All Share. Others will be more ‘unconstrained’, and will be flexible enough to move away from benchmark weightings.

Recent performance

Over the past five years, the average fund in the UK All Companies sector has grown by 122.5% (to 22nd January) and in the UK Smaller Companies sector by 212.3%. This compares to average growth from the UK Equity Income sector of 109.8%, and from the Global sector of 77.7%.

By far the best performing funds over the past one, three and five years have been those with a smaller companies bias, such as MFM Slater Growth and Cavendish Opportunities funds, though these funds will tend to suffer disproportionately when markets are trending lower. They were hit hard in the 2008 sell-off, for example.

The other top performers have been those with a flexible approach, where managers have not been forced to stick close to the benchmark. This is because the FTSE All Share is market capitalisation-weighted, and therefore has a higher weighting in larger stocks. As markets have generally disliked larger companies, the flexibility to move away from the benchmark has been a distinct advantage. Funds that fall into this category would include the Standard Life UK Equity Unconstrained fund.

The weakest funds have tended to be those focused on the mega-caps, which have trailed the wider market, or those where managers have had a free hand to back their best ideas and have picked badly. These are funds such as the Newton UK Equity fund, which has a large cap bias, or the Ignis UK Focus, which has suffered from poor stock picking.

When does it perform well/badly?

In general, growth companies will tend to perform better in an environment of buoyant economic growth. If companies and consumers have more money in their pockets it will tend to lead to stronger revenues for companies. Conversely, growth companies will do badly at times of weaker economic growth, because it becomes more difficult to generate profits. That said, funds within the UK All Companies and UK Smaller Companies sector will perform differently at different stages of the market cycle. For example, those focused on large cap, defensive companies such as tobacco, utilities or pharmaceuticals will tend to do better in a climate of weaker economic growth, where stock markets are struggling to make progress. In contrast, they will lag the wider market at a time of stronger economic growth and better stock market performance. In this environment, funds focused on smaller companies will tend to do well.

What sort of investor does it suit?

For many investors, a UK growth fund of one type or another will be the first fund they buy, and go on to form the core of their portfolio. Investors take little or no currency risk with a UK fund and will be familiar with many of the underlying companies held by these fund managers. It will suit an investor who does not need an income from their investments, and has a relatively long (3-5 year) time horizon.

How much of a portfolio for low/mid/high risk investor?

Most multi-managers have some UK growth funds as the core of their UK exposure. They may vary this between higher risk smaller company UK equity funds and more defensive blue-chip equity funds over the course of the market cycle, but UK growth funds are always likely to be a significant chunk of the UK exposure of the average investor.

Popular funds

Top 10 by performance (5 year) – UK All Companies

Standard Life Inv UK Equity Unconstrained

MFM Slater Growth

Cavendish Opportunities

SVM UK Opportunities

R&M UK Equity Long Term Recovery

Standard Life Inv UK Equity High Alpha

Neptune UK Mid Cap

L&G UK Alpha

Franklin UK Mid Cap

Barclays UK Lower Cap

Top 10 by performance (5 year) – UK Smaller Companies

Fidelity UK Smaller Companies

Cazenove UK Smaller Companies

Investec UK Smaller Companies

Marlborough UK Micro Cap Growth

FF&P Small Cap UK Equity

Henderson UK Smaller Companies

R&M UK Equity Smaller Companies

Unicorn UK Smaller Companies

Scot Wid HIFML UK Smaller Companies Alpha

Marlborough Special Situations

Questions to ask

– Do I want to be in large, blue-chip companies?

– Am I happy to take more risk in a smaller capitalisation or more flexible fund?

– Do I want a fund that will stick close to the index?

– Do I want to invest with a large fund group, or with a boutique group?

Investment adviser comments

Chris Sexton, investment director, Saunderson House

“We are leaning towards growth funds this year, believing that equities are neither cheap nor expensive, but fairly valued. That
said, smaller capitalisation companies did well last year and may not perform as well this year.”

Schroder Recovery

Fidelity Special Values

GVA UK Focus

BlackRock UK Special Situations

Patrick Connolly, financial planner, Chase de Vere

While we are positive about the outlook for UK equities, it should be remembered that the market has made strong gains over the past 18 months with relatively modest earnings growth. We need to see improved earnings in 2014 if stock markets are going to rise further in the short term.

BlackRock UK Special Situations

Investec UK Special Situations

M&G Recovery

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