Like many UK-based funds, smaller companies funds suffered significant outflows following the Brexit vote. But many of these funds have bounced back from this challenging period to deliver positive returns. Two renowned small cap managers talk about their fund performance, investment strategy and the dynamic UK smaller companies succeeding in a world of uncertainty.

“As a team, we encourage rigorous debate at each stage, to make sure that only the best stocks enter the Fund.” Harry Nimmo, Manager, Standard Life Investments UK Smaller Companies Fund.

How has Brexit affected your performance?

Harry Nimmo: The short answer is – it hasn’t, with the fund up around 35.8% since the vote1. It’s been a good year for small caps across most sectors, with many companies reporting “business as usual” in terms of trading. As for the fund, we’ve tended to favour companies with more international exposure; some 55% of revenues in our portfolios come from overseas. So, if anything, Brexit – and the consequent slump in the pound – actually helped our performance.

Luke Biermann: The fund suffered from the inevitable sell-off in UK smaller companies immediately after the UK’s not-so-inevitable vote to leave the European Union. However, since 30 June 2016 small caps have recovered considerably after being oversold. And, in sticking to bottom-up stock selection, the fund has returned 44.4%, versus a 27.2% return from the FTSE® Small Cap (ex IT) index2.

1Performance of Standard Life Investments UK Smaller Companies Fund, source: Financial Express Analytics, total return, net of fees, bid to bid with net income reinvested, 23 June 2016 to 31 October 2017, in sterling, Platform 1 share class.

2Performance of the Schroder UK Dynamic Smaller Companies Fund versus the FTSE® Small Cap Index (ex IT), source: Financial Express Analytics, total return, net of fees, bid to bid with net income reinvested, 23 June 2016 to 31 October 2017, in sterling, Platform 1 share class.

Past performance is not a guide to the future. As with any investment, the value can go down as well as up. An investor may not get back what they invested.

Where do you see growth coming from over the next three years?

Harry Nimmo: As ever, our focus is on quality companies with good business momentum and supportive Matrix scores. By concentrating on quality and sustainable growth stocks, we believe the fund can continue to generate positive returns with less risk and greater resilience at a time of general market uncertainty.

We’re finding company-specific prospects across a wide range of sectors. These include healthcare, notably in the animal companion space; food and beverages, where provenance and choice are key; support services; and IT. That said, we’re always mindful of opportunities in different sectors as and when we uncover them.

Luke Biermann: The smaller companies space is full of entrepreneurial management leading companies with clean exposures to pockets of structural growth. I find a number of themes particularly compelling.

One is technological penetration. This could be providing systems that allow companies to better manage increasingly complex and global organisations and supply chains. It could also be harnessing the rapid growth of data and information that allows organisations to more fully understand their customers’ habits and demands in order to better service them. Also, the migration of offline to online is causing disruption in both the consumer space and business-to-business – so there’s demand for offerings that can service that new customer demand.

We’re also paying attention to demographic trends, especially where millennials are increasingly the target audience. Millennials exhibit traits significantly different to their Gen X or Baby Boomer predecessors. One example is their desire to travel more and have experiences over products. Another is that they’re more socially mindful, with deeper interests in ‘global citizenry’, meaning they look at social and environmental impact and not just lowest price.

You can find out more about millennials’ desire for socially responsible investment options in Amanda Young’s recent blog.

Manager’s small-cap picks

Please note stocks mentioned are for illustrative purposes and not a recommendation to buy or sell.

Why small caps rather than large caps?

Harry Nimmo: The small cap story is well-known and remains firmly in place. For one thing, small caps tend to grow much more quickly than their large cap peers. Due to their size, they’re also more nimble and, thanks to superior innovation, can adapt and change quickly to new market trends. Many have also fully embraced the internet, giving them a material advantage over better-resourced large-caps.

In addition, due to the resources required to cover the sector, small caps tend to be less well-researched than larger companies. This means that a firm’s shares can rise sharply when markets finally spot its worth. The stellar success of our holding in Fever-Tree, also one of Luke’s success stories, is case in point.

Luke Biermann: There are number of reasons why we prefer smaller-sized UK companies. They can potentially offer faster rates of profit and dividend growth and higher long-term risk-adjusted returns than their larger counterparts. This is because they don’t suffer the rule of large numbers nor are they in the mature phase of their lifecycle.

Additionally, the small cap area of the market has many inefficiencies that we as active fund managers can capitalise on through stock selection and fundamental analysis. And as the small cap universe we explore is home to over 1,500 companies, many of which are under-researched especially when compared to the large cap space, we have the opportunity to uncover hidden gems.

Finally, smaller companies tend to have a narrower focus of goods, services and specialism than more diversified large companies. This allows for more pure investment in the undercurrents of change and advancement, which can offer significant upside when shrewdly analysed.

Please remember that the value of an investment can go up or down, and may be worth less than an investor pays in. Past performance is not a guide to the future.

This article is directed at professional investors and should not be distributed to, or relied upon by, retail investors. Content in this section is provided by Standard Life Investments and external fund groups. It does not constitute any financial or other professional advice or recommendations.

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