Brexit bonanza for UK small cap funds

One of the biggest beneficiaries of the Conservative majority could be the UK small cap sector where many of the constituent stocks are geared towards the local economy.

The comfortable winning margin provides a clearer view on Brexit that ends a lot of the uncertainty. When you factor in the prospect of higher government spending and tax cuts it seems likely that UK domestic stocks will experience a decent rally.

It is possible that the large majority will give the Prime Minister the negotiating power to get a good trade deal from Europe. This is especially true given that he is less dependent on the support from the European Research Group (the ERG) and might be able to avoid the potentially damaging hard Brexit that they have been pushing for.

If this is the case then 2020 could be a good time to have a decent exposure to the UK small cap sector, where many of the stocks operate entirely within the local economy. The easiest way to do this is to invest in one or more of the specialist funds that operate in this area.

Could 2020 be the year that value makes a comeback?

There are lots of decent options to choose from, but if you think that 2020 could see value stocks come back into favour then the Aberforth Smaller Companies Trust (LON:ASL) would be the obvious one to go for.

The £1.3bn investment trust is the largest in the sector and the managers have a disciplined value approach. They have put together a 79-stock portfolio that has already benefitted from the election result with the shares up around six percent from last Thursday’s close and the discount narrowing from its 12-month average of nine percent to just two percent.

Another possibility would be the Henderson Opportunities Trust (LON:HOT) that I mentioned in my recent post ‘the best funds to hold going into the general election.’ This is a much smaller fund with assets of £105m and has been out of favour, with the shares trading on a 17% discount, but the improvement in sentiment since the general election has led to a nice bounce that could herald the start of something more significant.

One of the most highly regarded small- and mid-cap teams

If you prefer open-ended funds you might want to consider the £1.1bn Merian UK Smaller Companies. The firm has one of the most highly regarded small and mid-cap teams, headed by Dan Nickols, who is the manager of this fund.

Nickols has a pragmatic approach that allows the portfolio to contain growth, value and recovery stocks, although it has tended to have a growth bias. There are currently 87 holdings and the fund has comfortably outperformed its benchmark and sector average over the last five years. In fact the return has been almost double the 40% achieved by the Numis Smaller Companies index during this period.

The uncertainty surrounding Brexit has meant that the UK stock market has been out of favour for years, with investors shunning domestically-oriented companies. Now that there seems a clear pathway to a resolution there could be a swift reappraisal with the small caps one of the biggest potential beneficiaries.