When the UK voted to leave the European Union last year, the UK stock market sold off sharply and sterling tumbled to a 30-year low against the dollar. But it has since bounced back and hit record highs, in part due to the boost that the weaker pound has given UK exporters and overseas earners.
Analysis by asset manager Fidelity International shows that if you had invested £10,000 in the FTSE 100 on 24 June 2016, the day after the EU referendum, you would now be sitting on £12,565 - a 26 per cent uplift.
But among UK equity funds, smaller companies were the winners between 24 June 2016 and 15 June 2017, according to FundExpert.co.uk, which looked at the average return for funds greater than £50m in size in the main UK equity sectors. Over that period, the UK Smaller Companies fund sector made an average return of 36 per cent, ahead of the UK All Companies sector average of 27.6 per cent and the UK Equity Income sector average of 24.5 per cent.
"The performance of UK smaller companies is reassuring," says Brian Dennehy, managing director at FundExpert.co.uk. "If investors had little faith in the prospects for the UK we'd expect to see smaller companies weakening. While investors could do with more certainty around the make-up of the UK government and the substance of Brexit negotiations, the strong returns for the sector show that the prospects for the UK are good."
However, it will be important to continue monitoring the health of UK smaller companies going forward.
"If we start to see weakness in smaller companies, it could be a good indicator of weakness in the economy," says Sam Lees, head of research at FundExpert.co.uk.
Smaller companies tend to outperform over the long term, in particular, because they are under-researched, making it easier to find hidden gems. But the immediate case for UK smaller companies is less certain, argues Darius McDermott, managing director of Chelsea Financial Services. "At some stage there will be a Brexit slowdown and it ought to hurt smaller companies," he says.
Another area that has done well over the past year is Europe-focused funds. The Investment Association (IA) European Smaller Companies sector average return was 34.7 per cent between 23 June 2016 and 19 June 2017, while the IA Europe ex UK sector average return was 34.2 per cent, according to Chelsea Financial Services.
"We favour Europe from an equity point of view as it is benefiting from new growth and a little inflation," says Mr McDermott. "The deflation worries seem to be receding and the stock market is less fully valued than the US and the UK, so it's perfectly possible that it could do well over the next 12 months."
Although UK markets have been more resilient than many would have expected a year ago, several asset classes have performed even better over the same period.
Fidelity International found that between 24 June 2016 and 15 June 2017, Asia Pacific equities returned 36.9 per cent, emerging market equities returned 36.2 per cent and European equities made 35.8 per cent.
"In the grand scheme of things, the UK plays a small part in the overall global economy and whatever the outcome of the Brexit negotiations, the US economy will continue to recover, Europe will remain on the mend and emerging markets will continue to outstrip the growth in the developed world," says Tom Stevenson, investment director for personal investing at Fidelity International. "With this in mind, it pays to have a well-diversified portfolio."
The importance of having overseas exposure has been highlighted by sterling's devaluation. "The fall in the pound has been the key driver of market returns in the UK over the past year, and will be the key driver of the economy and markets over the next 12 months," says Mr Stevenson. "UK investors with overseas exposure had a double whammy in the past year with good performance of the underlying markets and the magnification effect of the currency [when translated back into sterling]."
Mr Stevenson thinks that many of the areas that performed well in the past year look set to perform well again over the next year. These include Asian and emerging markets, which have long-term positive structural forces powering them, while markets such as Japan and Europe are relatively cheaply valued and enjoying economic recoveries.
However, if the UK and the EU are not able to agree on a new trading arrangement, it could have negative consequences for both their markets.
Valuations of US equities, meanwhile, look expensive - despite recent growth. "The key unknown in the US is the extent to which the Federal Reserve [the US central bank] feels able to tighten monetary policy," explains Mr Stevenson. "There's quite a high degree of doubt about the ability of the US economy to withstand the kind of tightening the Fed is looking at, of a new normal of around 3 per cent. It depends how quickly it raises rates, but it could be quite challenging for the US."
Top 10 performing UK funds between 24 June 2016 and 15 June 2017
|TM - Cavendish Aim||UK Smaller Companies||58.07|
|Old Mutual - UK Mid Cap||UK All Companies||47.74|
|Jupiter - UK Smaller Companies||UK Smaller Companies||46.7|
|MI - Chelverton UK Equity Growth||UK All Companies||46.58|
|Old Mutual - UK Smaller Companies||UK Smaller Companies||45.74|
|Marlborough - UK Micro Cap Growth||UK Smaller Companies||43.86|
|Threadneedle - UK Smaller Companies||UK Smaller Companies||43.15|
|Schroder - UK Dynamic Smaller Companies||UK Smaller Companies||42.93|
|Schroder - UK Smaller Companies||UK Smaller Companies||41.48|
|Artemis - UK Smaller Companies||UK Smaller Companies||40.92|
Top 10 performing European and UK equities funds between 23 June 2016 and 19 June 2017
|Henderson European Smaller Companies||56.6|
|Neptune European Opportunities||55.8|
|Marlborough European Multi-cap||55.7|
|Old Mutual UK Smaller Companies Focus||55.5|
|JB Multistock Euroland Value Stock||52.4|
|TM Cavendish Aim||51.2|
|Comeragh European Growth||47.3|
|Schroder European Smaller Companies||46.6|
|Baillie Gifford European||44.2|
|Old Mutual European (ex UK) Smaller Companies||44.2|
Source: Chelsea Financial Services, total returns in Sterling
Performance of asset classes between 24 June 2016 and 15 June 2017
|Asset class||Performance %|
|Asia Pacific equities||36.89|
|Emerging market equities||36.23|
|European (ex UK) equities||35.75|
|Emerging market debt||15.81|
Source: Fidelity International sourced from Datastream, total returns in sterling.