Franklin UK Smaller Companies – ‘Boris bounce’ adds shine to a good year

UK equities sprang to life in the second half of 2019. Rob Morgan looks at one fund that has benefitted.

This content is more than 6 months old now, please visit the news area of this site for more recent content

  1. Rob Morgan

After a period in the doldrums, UK equities sprang to life in the second half of 2019. The announcement of a December General Election, the growing likelihood of a Conservative victory and the conclusive result were all catalysts for improved sentiment, particularly in domestically focused areas.

It, therefore, ended up being a great year for many UK smaller companies funds. Smaller businesses often derive much their earnings from the domestic economy so tend to be more influenced by the prevailing political climate than many larger ones. With the perceived risk of a less market-friendly Corbyn-led government eliminated they benefitted from a sense of relief in the immediate aftermath of the election.

Franklin UK Smaller Companies, one of our favourite funds in the sector, was no exception to the strong returns across the sector. It is managed in a disciplined but pragmatic fashion with a bias towards good-quality businesses, encompassing both faster-growing companies and less expensive ‘value’ stocks. We added the fund to our Foundation Fundlist in January 2017, identifying it as an underperformer in 2016 that might be due a return to form – and it has not disappointed.

Given the neutral style, we expect performance versus its index to be primarily driven by stock selection, with the fund having the ability to perform well throughout a market cycle. Unlike some peers, the fund remains nimble enough to invest in the managers’ preferred ‘sweet spot’ for UK smaller companies, which is between £100m to £1bn in size.

Diverse and dynamic

Manager, Richard Bullas, characterises UK smaller companies as one of the most sophisticated, diverse and dynamic in the world, giving exposure to an exciting and large range of companies. However, there is lingering uncertainty surrounding many businesses as the path of Brexit trade negotiations is unclear.

The managers calculate that around two-thirds of the revenue of the underlying companies in their portfolio can be attributed to the UK and one third overseas. By contrast, FTSE 100 companies derive around three-quarters of their revenue internationally. This implies that were negotiations to progress favourably, this fund, along with others in the sector, could fare relatively well versus broader UK funds – though of course the reverse is true and UK smaller companies investments could suffer if investors perceive that the UK economy could be hit hard by trade barriers or tariffs.

Fund activity

Despite the political backdrop, it is business as usual for the fund’s managers, who believe there are still some excellent opportunities despite December’s ‘Boris bounce’ pushing up share prices. They point out that the forward price-to-earnings ratio* for non-loss makers in the FTSE Small Cap index is currently at a 25% discount to their larger company equivalents in the FTSE 100.

Domestic UK exposure is significant but selective. Sofa seller DFS, Topps Tiles and Hotel Chocolat feature in the portfolio, providing some retail exposure, but support services is the largest sector overweight through holdings in Clipper Logistics, Equiniti, Ricardo and Robert Walters. Travel and leisure stocks are mostly avoided at present, with the managers concerned balance sheets among pub companies, in particular, are stretched.

Recent new purchases include Codemasters (video games), Watkin Jones (construction) and SMS (smart metering), and existing positions in adhesive component manufacturer Scapa and video game developer Sumo Digital have been increased on share price weakness. The fund’s largest holdings remain broadcast and photographic provider Vitec and documentation management company Restore.

Table: Discrete annual % performance of Franklin UK Smaller Companies Fund versus sector and benchmark

Discrete annual % performance of Franklin UK Smaller Companies Fund versus sector and benchmark

Past performance is not a reliable indicator of future returns. Figures are shown on a % total return basis, bid to bid price with net income reinvested; Source: FE Analytics.

 

Our view

We believe the UK stock market is a better value than many overseas markets, with many smaller companies particularly unloved by investors. The value on offer potentially means an exciting, albeit higher risk, longer term opportunity, and one that could add important diversification to a portfolio.

This fund has done a good job in capturing the growth and dynamism of the smaller companies market since the current managers took charge in 2012, albeit with a more conservative valuation discipline than some of its peers. We remain positive despite one member of the wider team, Paul Spencer, recently announcing his retirement.

The fund contains a good balance, which means it doesn’t rely on a particular investment style or a small number of sectors. It is, however, concentrated – 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. Of course, the opposite is true if they don’t.

We also believe the fund still benefits from its small size, which allows it to invest flexibly across the range of opportunities presented. The manager is particularly active in the smaller end of the smaller company universe where larger funds find it harder to secure meaningful stakes. The fund remains part of our Foundation Fundlist of preferred investments across the major sectors for new investment.

*The price-to-earnings (P/E) ratio measures how expensive a share is relative to its annual per-share earnings. A ‘forward’ P/E considers the year ahead, which is based on estimates, as opposed to a historical P/E which is based on earnings already declared.

 

Past performance is not a reliable guide to future returns. This website is not personal advice based on your circumstances. No news or research item is a personal recommendation to deal. Investment decisions in fund and other collective investments should only be made after reading the Key Investor Information Document or Key Information Document, Supplementary Information Document and Prospectus. If you are unsure of the suitability of your investment please seek professional advice.

More from author

  1. Rob Morgan

    How much can you contribute to a pension?

    Date: 16th Jan 2020 10:58am

    Pensions are often a highly effective means of investing for retirement owing to the ...

  2. Rob Morgan

    UK investors to increase socially responsible investment exposure

    Date: 16th Jan 2020 10:58am

    We have commissioned some research into investor attitudes towards Socially Responsib...

  3. Rob Morgan

    BNY Mellon Real Return – aiming to plod rather than leap

    Date: 16th Jan 2020 10:58am

    This fund holds a diverse portfolio of assets, aiming to generate decent long-term re...

Most read articles

  1. Franklin UK Smaller Companies – ‘Boris bounce’ adds shine to a good year

    BNY Mellon Real Return – aiming to plod rather than leap

    Date: 16th Jan 2020 10:58am

    This fund holds a diverse portfolio of assets, aiming to generate decent long-term re...

  2. Franklin UK Smaller Companies – ‘Boris bounce’ adds shine to a good year

    Is the Tesla share price rise justified?

    Date: 16th Jan 2020 10:58am

    Baillie Gifford funds have been among the beneficiaries of a sharp rise in Tesla shar...

  3. Franklin UK Smaller Companies – ‘Boris bounce’ adds shine to a good year

    January’s most widely bought and sold funds

    Date: 16th Jan 2020 10:58am

    We reveal the funds most commonly bought and sold by customers using our investment p...

Investment involves risk. You may get back less than invested.