UK small cap funds 'surprise' with outperformance since Brexit vote
Average product returned 33.13% over past three years
The IA UK Smaller Companies sector has been the only open-ended UK equity sector to beat the FTSE All-Share since the UK voted to leave the EU, research from Investment Week and data from FE shows.
This is despite the fact UK small caps have a reputation for being more dependent on the UK economy than their larger, global-facing peers.
The average UK smaller companies fund, sitting in the Investment Association's UK Smaller Companies sector, has returned 33.13% since 23 June 2016 to 19 March, while the FTSE All-Share and FTSE 100 indices have gained 27.19% and 28.41% respectively.
Meanwhile, the average return of the IA UK All Companies and IA UK Equity Income sectors resides at a respective 22.27% and 18.15%.
Why have small-cap funds outperformed?
Ben Yearsley, managing director of Shore Financial Planning, said the fact IA UK Smaller Companies funds outperformed their larger counterparts on average since the referendum, now over 1,000 days ago, is surprising given their domestic focus and lower levels
of liquidity.
Three hidden gems in the UK small-cap sector challenging their larger peers
"In theory these should have been hit hardest," he commented.
"I wonder whether it is simply down to less overseas ownership - while [overseas investors] have been reducing their UK exposure, this has mainly been among large and mid caps as that is where their focus was.
"I do not think market cap itself makes much difference to Brexit, it is down to company-specific reasons - you can buy a large-cap domestic portfolio and small-cap overseas one, and vice versa."
Adrian Lowcock, head of personal investing at Willis Owen, pointed out that while smaller companies are theoretically more vulnerable to an economic slowdown or recession, they are less susceptible to the politics of Brexit itself as most smaller companies do not do business with the EU.
"There are a number of factors that make smaller companies attractive irrespective of Brexit," he explained.
"Small companies are able to operate in niche markets. They can also utilise technology effectively and are able to grow rapidly - they do not necessarily need the economy to perform well in order to grow.
"In addition, smaller companies are self-help orientated as management teams are used to dealing with changes and challenges on a regular basis. This means smaller companies are well positioned to navigate Brexit irrespective of its flavour."
Lacklustre UK equity income funds
In contrast, funds in the IA UK Equity Income sector have struggled to keep pace since the EU referendum.
Darius McDermott, managing director of Chelsea Financial Services, said this is because growth stocks have outperformed over recent years and quality has been favoured over value, which he said has served as a "double whammy" for dividend-paying UK companies.
"Our contrarian view is that investors should consider upping their exposure to UK equity income," he reasoned.
"Dividend yields are at an extreme level compared to gilt yields and the income will cushion the impact of any bad news. Should there be good news, a return to favour of UK stocks generally will be a positive."
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