Fidelity UK Smaller Companies
There are multiple considerations at play when it comes to investing for a child. Some parents might wish to invest ethically or sustainably with an eye on bettering the world their offspring will inherit. Others might simply use the long timeframe available to take plenty of risk in the hope of compounding serious gains over the years.
This year we have opted, once again, to highlight a name from the second group. There are plenty of high-risk portfolios out there with the potential to deliver strong returns, from emerging market funds to private equity vehicles. But this year we highlight a value play close to home.
UK equities have staged a decent comeback in recent times, with the FTSE 100 up by around 30 per cent over the three years to the start of March. That strong recovery hasn’t quite fed through to smaller companies, however, with the FTSE Small Cap index returning just 8.3 per cent over the same period. With valuations relatively attractive as a result, this could be a good moment to buy into UK smaller companies, with the emphasis on staying invested for a substantial period and riding out the inevitable ups and downs.
The funds universe is replete with UK small-cap portfolios, and these can take surprisingly different approaches. One detail that warrants attention is just how concentrated a fund is. Some funds, such as Odyssean (OIT), have extremely large positions, while others have many small holdings in order to offset the risk taken on each business.
One fund that has diversified well while still generating strong returns is Fidelity UK Smaller Companies (GB00B7VNMB18). It has more than 100 holdings, with its top position accounting for just 2.4 per cent of the portfolio. The managers are contrarians, favouring companies “that have gone through a period of underperformance but where there are unrecognised growth options”. Recent holdings include Coats Group (COA), Serco (SRP) and Elementis (ELM).
The fund has a track record of strong performance, and now appears a good time for it to pick up more bargains.
STARTING YOUR PORTFOLIO
Brunner Investment Trust
There’s a good argument for using a broad global fund, be it active or passive in nature, to kick off your investing journey. It should ensure some diversification while giving you decent exposure to the market leaders.
A recent problem is that the market leaders have grown so prominent. The so-called Magnificent Seven stocks account for more than a fifth of the MSCI World index, while the US market as a whole makes up almost three-quarters of it. Were the tech sell-off we’ve seen so far this year to carry on in earnest, global funds could sustain big losses.
Investors might therefore be tempted to invest in a fund that has exposure to the likes of US tech but that makes material investments elsewhere, too. And Brunner Investment Trust (BRUN) is one global equity trust that has managed to generate strong returns without relying heavily on the market leaders. It does have some exposure, with Microsoft (US:MSFT) as its top holding on a 6.4 per cent weighting, but its overall allocation to US tech majors is limited. Alphabet (US:GOOGL) is the only other Magnificent Seven member among the fund’s top 20 holdings. It also has fairly limited exposure to North America, at 46.1 per cent of assets, with roughly 23 per cent apiece in the UK and Europe. The team looks for stocks across the world that can provide “growth and reliable dividends”, with other top holdings including Visa (US:V), Taiwan Semiconductor Manufacturing (TW:2330) and Shell (SHEL).
There’s always the possibility that the market leaders continue to race ahead, meaning that those erring on the side of caution miss out on some gains. But this fund has done very well in recent years, despite having trodden a different path.
JPMorgan Emerging Markets
Most global funds (including Brunner) tend to have little or no exposure to emerging markets, which have had a tough decade but have the potential to make good returns in the long term. Investors concerned about the recent bad run may well wish to keep their position size small, but expanding into emerging markets is a valid option for those looking to broaden their investments.
Investors are spoiled for choice when it comes to Asian and emerging market equity funds, but one name that sits in our 2024 Top 50 Funds list is JPMorgan Emerging Markets (JMG). The investment team tries to find companies with sustainable and consistent above-average earnings growth and then sticks to its guns, taking big positions and tending to hold companies for a long time.
Its list of top 10 holdings includes plenty of high-profile emerging market names, from Taiwan Semiconductor (on a 13.4 per cent weighting) to Chinese internet giant Tencent (HK:700) and Samsung Electronics (KR:005930). The fund has big weightings to India, China and Taiwan.
We like the slow and steady approach of this fund, as well as its focus on quality in an unpredictable market. But we should recognise that the fund’s returns have been poor in recent years, something that can be partly attributed to its China exposure. We hope for a return to form in the longer run.
DIVERSIFYING AND DE-RISKING
Amundi UK Government Bond ETF
At the risk of sounding like a broken record, we are sticking with an option highlighted last year in the form of the Amundi UK Government Bond ETF (GILS). Bond yields, which move inversely to prices, are still fairly high, offering a good level of income but also providing room for valuations to rise if we see a panic in the equity market. The yield on a 10-year UK government bond recently came to 4.5 per cent.
Given that active managers often struggle to make much in the way of extra gains from the government bond market, this passive option continues to stand out. The fund gives investors a cheap way to access a diversifying asset, with a spread of exposure to different bonds.
Last year, we caveated that investors could lock in returns by simply buying government bonds directly if they wished. That argument is helped by the fact that gilts are completely free from capital gains tax (a helpful attribute should their value rise between the time of purchase and their maturity date). Interest payments, however – now much higher on newer bonds than they were just a couple of years ago – are subject to income tax.
Turning back to this fund, it comes with a very attractive yield of
4.5 per cent. Its performance is (hopefully) fairly predictable in relation to market conditions. A sell-off in the equity market or an economic scare should see it perform well, but rising interest rates or high levels of inflation could hurt returns. Holding it alongside equity funds should provide a good level of balance.
Artemis Income
Income can stem from many sources, from alternative asset classes such as infrastructure, to bond and equity income from all corners of the earth. So investors can certainly broaden their horizons here. But the fund we highlight here has focused, with great success, on domestic shares.
Artemis Income (GB00B2PLJJ36) is the biggest fund in the Investment Association’s UK Equity Income sector, ie far from a hidden gem. But we like the fact that it has generated both a reasonable income and some very strong total returns over the years. Its yield comes to around 3.5 per cent, in line with that of the broader market, and the fund has returned around 37 per cent over the three years to 26 February 2025.
The investment management team looks for companies with a strong free cash flow yield; it considers current and prospective dividends and the likelihood of payouts being maintained in future.
Around a third of the portfolio is in financials, with consumer discretionary shares accounting for slightly less than that. The fund’s most prominent positions are in Pearson (PSON), 3i Group (III), London Stock Exchange (LSEG) and Tesco (TSCO). The portfolio is predominantly invested in large-cap shares, with a small allocation to mid-caps.
The fund tends to hold between 45 and 65 stocks and, while its biggest positions are north of 4 per cent in size, the team does seek to “avoid overexposure to any one industry or company”. Position sizes reflect the team’s expectations in terms of returns.
THE ETHICAL/SUSTAINABLE CHOICE
Greencoat UK Wind
We mentioned above that those investing in a Junior Isa might seek an ethical fund of sorts, and such leanings may of course also apply to all types of investor. The choice of ethical or sustainable funds is wide and varied, with some funds looking to hold companies that actively seek to make the world a greener or more sustainable place, and others simply avoiding ‘sin’ stocks.
Ethical investing is not restricted to equity funds, with investors also able to back portfolios that hold assets such as wind farms. Some of these portfolios have struggled in recent years in the face of rising interest rates, unpredictable power price fluctuations and the turmoil that has engulfed the investment trust sector. But backing physical assets is a compelling way to make a sustainable choice, and this approach tends to come with high dividend yields and, for now, what appear to be low prices.
It’s not hard to guess the focus of Greencoat UK Wind (UKW) and there’s a lot to like about the shares. They trade on a discount of more than 25 per cent to its stated portfolio value, and on a dividend yield of more than 9 per cent. UKW also has substantial scale, making it less likely to fall victim to the merger activity now common in its sector. Its dividend is fairly well supported by its revenues and the trust has responded to its wide discount with substantial share buybacks, but still maintains what some analysts dub a “disciplined” approach to capital allocation.
The trust is certainly not immune to the challenges that face its sector, reduced power prices recently dealing another blow to its portfolio value. But it’s a way of investing directly in a more sustainable future, and looks to be on a more stable footing than many of its peers.
