What to own alongside your giant UK equity fund

Recent years have been unkind to UK equity funds, with investors pulling billions from the sector amid a fog of uncertainty. But those who stayed the course or even took advantage of low valuations have been rewarded by a bounce in some parts of the domestic market over the past year. The FTSE 100 index serves a few purposes, including as a source of income and a way to get cyclical exposure not so readily available elsewhere.

If you prefer funds to picking shares, you are especially spoiled for choice when it comes to UK equity exposure. However, a few funds dominate in this area, with names such as Liontrust Special Situations (GB00BG0J2688), LF Lindsell Train UK Equity (GB00BJFLM156) and Artemis Income (GB00B2PLJJ36) running huge levels of assets. Data from Hargreaves Lansdown (HL) and Interactive Investor also indicates some level of crowding among self-directed investors, with LF Lindsell Train UK Equity among the five most popular UK equity funds on these investment platforms in 2022.

Such funds often have a storied track record and a well-established investment team. However, other funds can be held either to complement these or as an alternative offering something completely different. In such a large sector, the variety of options is extensive.

The big names

From the biggest funds by size to those that have recently proved popular on the two largest investment platforms, a number of the names mentioned share similar traits. Liontrust Special Situations invests via a quality growth style, and its investment team’s “economic advantage” process seeks to identify companies with intangible assets that create barriers to entry and a lasting edge to hold off industry competition and maintain a chunky level of profitability. LF Lindsell Train UK Equity also has a focus on quality and aims to invest in resilient, established companies with strong brands. Funds that invest via an environmental, social and governance approach often have a quality or growth bias, and Aegon Ethical Equity (GB0007450884) made it into the top five funds bought by Hargreaves Lansdown customers in 2022 while Royal London Sustainable Leaders Trust (GB00B7V23Z99) was among Interactive Investor’s customers’ five most popular funds last year.

Although the UK is commonly seen as a value market, these funds have very different style biases, which are worth offsetting. We found that active funds with different investment styles had fared well versus the underlying market over the longer term (‘Active fund pairs versus the market’, IC, 13 May 2022). For example, a portfolio split between Liontrust Special Situations and deep value play Schroder Recovery (GB00B3VVG600) held up well against the FTSE All Share, even if this didn’t hold up in shorter periods. Other popular value funds such as Jupiter UK Special Situations (GB00B4KL9F89) could be paired with Liontrust Special Situations or used as a different way to play the UK market, thanks to the Jupiter fund’s focus on undervalued companies. These funds had different experiences in 2022 with the quality growth ones struggling while value portfolios held up well.

Other differences

Some of the same considerations apply to both growth and income funds. These include their market cap exposure as some established funds have a preference for large-cap stocks, especially in the income space. Artemis Income had 80.2 per cent of its portfolio in large caps at the end of March, putting it at one extreme, although some funds have a more nuanced approach. Man GLG Income (GB00B0117D35), a relatively large income fund and one of the five most popular names among Interactive Investor customers in 2022, had a 56.9 per cent weighting to FTSE 100 stocks at the end of April and just under a third of its portfolio in FTSE 250 shares.

Growth funds can also have a mixture of exposures, with Liontrust Special Situations tending to have an allocation to small and mid-cap stocks despite its substantial size. You should weigh up such nuances but might want to complement more mainstream funds with those that focus on small and mid-cap shares. There are a number of multi-cap income funds such as Diverse Income Trust (DIVI) and FP Octopus UK Multi Cap Income (GB00BG47Q663). These should complement more blue-chip-oriented income funds nicely and offset some of the risk of more conventional income funds relying too heavily on a handful of huge companies for their income. It’s likely that one of the funds will fare well while the other struggles but holding two together should provide diversification.

The same thinking applies to growth investing. Many UK funds hold a combination of large, mid and small-cap stocks, but you could take a more granular form of exposure. Options for smaller companies exposure include BlackRock Smaller Companies Trust (BRSC) and BlackRock Throgmorton Trust (THRG). These have been trading on big share price discounts to net asset value, with BlackRock Smaller Companies recently on a discount of around 14 per cent and dividend yield of 3 per cent, suggesting that investing further down the market cap spectrum doesn’t necessarily involve sacrificing income. BlackRock Throgmorton Trust has tended to have a combination of exposure to small and mid-cap stocks, and has outperformed many dedicated small-cap funds at times. However, the growth bias of such funds left them particularly exposed to the sell-off in 2022, with investors also worrying about how smaller companies might hold up if a recession emerges this year.

But some investors favoured going even smaller last year, with IFSL Marlborough UK Micro-Cap Growth (GB00B8F8YX59) among the five most bought UK equity funds by Hargreaves Lansdown and Interactive Investor customers in 2022. However, it could make sense to allocate smaller portions of your portfolio to funds such as small-cap specialists that can have a greater level of risk.