By Sid Chand Lall, manager of the IFSL Marlborough Multi Cap Income fund
You are probably tired of hearing that UK equities are making a comeback. To be honest, I am somewhat bored of this narrative myself. As an exasperated film producer once told his scriptwriters: “We need some new clichés!”
The problem is not that this line has been flogged to death or even that it has occasionally been rooted more in hope than in fact. What really irks me is that it conveys only a fraction of a much bigger story.
For instance, it is now easy enough to say UK income funds are at last recovering from the tumult of Covid and the political and economic chaos of two years ago. In tandem, it is also easy enough to say a perfect storm is giving way to more benign conditions – as defined by dynamics such as falling inflation and a cut in interest rates.
Yet I am not sure the generalisations and broad-brush “insights” that are customarily wheeled out truly help investors. They might generate renewed interest in UK equities as a whole, which is obviously welcome, but they shed little light on the nuances and shifts shaping this sector.
The reality is that this market, like any other, is highly diverse. A sweeping, “one size fits all” perspective is therefore unlikely to prove ideal. This is why we need to take a closer look at the principal drivers of performance over time.
Rolling back the years
Another narrative that has become wearily familiar of late surrounds the so-called “Magnificent Seven” US tech stocks. Alphabet, Amazon, Apple, Meta, Microsoft, Nvidia and Tesla were responsible for approximately 60% of the S&P 500’s total return in 2023 and continued to dominate during the first half of 2024.
Although less pronounced, a similar effect has played out in the UK. Led by a handful of notably potent performers – including AstraZeneca, GSK, Unilever and RELX – large-cap companies did much of the heavy lifting during and in the immediate wake of the COVID crisis.
Recently, however, success has been more likely to come from the opposite end of the market-cap scale. Smaller companies have frequently been the main drivers of returns over the past 12 months or so.
Data for my own fund demonstrates this turnaround. Small-cap holdings added more than 5% to relative returns during the year leading up to the end of May 2024, whereas large-caps contributed just 0.6%. This suggests small-caps’ historical outperformance over their large-cap counterparts is reasserting itself.
Yet there is still a lot more to learn about UK equities. A focus on small-caps can clearly be beneficial, but it is also important to appreciate the types of stocks that may warrant particular attention in this arena.
Peeling back the layers
We have established there may be merit in diversifying across market-caps, yet there may also be merit in diversifying within them. We can illustrate this by considering three stock profiles in the burgeoning small-cap space.
Bloomsbury Publishing is a good example of a slow burner. We first invested in it around a decade ago. For many years its share price remained in a healthy yet narrow range, but since the start of 2021 it has more than doubled.
Crucially, the company has greatly expanded its strategy. As a result, long-term investors’ patience is now being rewarded – and Bloomsbury has graduated from the FTSE SmallCap Index to the FTSE 250.
Construction group Galliford Try is a business whose attractions have become more apparent only during the past year or so. We returned to this name last September, since when the share price has risen by in excess of 20%.
A new CEO, the settling of historical contracts and additional potential for increased margins are making a significant difference to the company. The backdrop of an interest rate reduction helps sentiment, although a strong Budget in October is needed to make it more meaningful.
There are also businesses that are enjoying impressive recoveries. Take the Mortgage Advice Bureau, which has claimed sizeable market share amid a downturn in housing transactions and is currently up more than 80% from the low it hit almost a year ago.
Bouncing back from turmoil
The key lesson here, then, is that it is not sufficient to say UK equities are on the rise. Nor, strictly speaking, is it sufficient to say small-caps are leading the charge.
This story instead needs to be seen through a much sharper lens. Specifically, it needs to be seen through the lens of informed stock-picking.
Of course, you might think the case for expert portfolio construction and active management is itself something of a cliché. But I would argue that, like so many oft-told tales, it also happens to be true.
Sticking to a tried and trusted investment process in the face of turmoil can pay off in the long run. Irrespective of volatility and uncertainty, we believe a commitment to identifying the most promising small-cap opportunities will ultimately serve investors well.
