Don’t blindly follow the herds into the big cap funds

DESPITE large-cap funds having underperformed against their small to mid-cap alternatives in recent years (see chart), figures would suggest that this year could see large-cap funds turn the tables.

“We have certainly seen a lot more interest in equities, away from bonds and gilts,” said Andy Simpson at Schroders Asset Management, “though not as attractive as 18 months ago, they are attractive nonetheless.”

As is typical with almost all things financial in current times, the move into large-cap funds follows the common theme of risk aversion. According to Simon Gergel, manager of Allianz RCM UK Equity Income Fund: “large-caps do better when people think that things are going to get worse. With current volatility in the market, there will be flight into the large-cap funds. There are a lot of large-caps yielding attractive dividend payments and on the whole are undervalued in the market. With the likes of Vodafone yielding 5 per cent and GlaxoSmithkline 5.5 per cent, both above inflation, they are an attractive proposition.”

There is also a trend of people realising that, away from the exotic climes of the emerging markets, which are beginning to see valuation multiples approaching those of developed markets, opportunities for healthy returns can be had closer to home. Anthony Cross is a fund manager who runs the Special Situations, UK Growth and UK Smaller Companies fund at Lionfund. He has started to see this move in favour of what people see as “safe” equities: “with worries about inflation and tightening of interest rates in the emerging markets that performed so well last year, people are realising that there are good businesses listed in London that provide exposure to those markets without the risks. Unilever is an obvious example of this, doing a large percentage of its business in developing countries.”

With what seems to be the consensus that there is broadly an undervaluation of the big name equities, it would seem that large caps are the path to take, however, it pays to dig deeper. Chris Wyllie, chief investment officer of Iveagh Wealth, advises that you ought to scratch below the surface “looking at PE (price-earnings ratio), large-caps look under-valued. However when you take a look at the median, the under-valued stocks are relatively few in number. It what this shows is that there is a lot of value concentrated in a small number of shares.” He advises that when you look under the surface, “the average stock is nowhere near as cheap as price-earnings figures would suggest. For the retail consumer, a cap index tracker will avoid the expensive funds that a lot of actively managed funds would expose you to.”

Richard Hallett, lead manager on the Marlborough UK Leading Companies fund has also seen more of a sectoral shift, rather than from small-cap to large. “Although there has been an increase in people taking up large-cap funds, that has not necessarily been to the detriment of inflows into small-cap funds. We have seen more sector specific changes. We are overweight in industries for example.”

Another reason to beware of retreating to the safety of the large-cap funds is the risk of losing out on the upturn, in which large dividend-paying companies will lag behind the stocks of smaller companies and highly leveraged companies. As such, investors should be aware of the value and safety to be found in large-caps, but should look beyond the headline price multiples and avoid over-priced stocks hidden beneath the surface.