Under-the-radar stock pickers to back this tax year

Investing 1.01 is to buy low and sell high. Unfortunately, it’s emotionally easier to buy the popular stocks that everyone likes, rather than unloved areas that everyone is trying to ignore. However, these unloved areas may be a fertile source of ideas for this year’s ISA season.

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Pros and cons of going against the crowd

Funds may fly under the radar for a number of reasons. They may be in an area that investors actively dislike. At the moment, that might include the UK, or smaller companies. Or these funds may be too small to command attention. Many institutional buyers will only start to take an interest when funds reach £300 million or £400 million. Alternatively, they may be investing in a new growth idea still overlooked by investors.

Finding these funds can be reward the effort. Institutional buyers can suddenly take an interest when a fund hits a certain size, which is good for existing shareholders. Equally, investors may catch on to a trend, and momentum starts to build.

In addition, investors may hit a sweet spot for performance – somewhere between when the fund is large enough to have economies of scale, but not too big to lose flexibility. Rather than being forced to invest in large, less exciting companies because it is the only place they can get sufficiently liquidity, small funds can be nimble. For this reason, some sectors, such as smaller companies are particularly sensitive to size.

It is worth noting that there are also potential downsides to these funds. If an area is actively disliked, it can take time for sentiment to change. New ideas may never capture investor imagination. At the same time, smaller funds have higher fixed costs, which will often raise the yearly fund charge fee. This can act as a drag on performance.

Also bear in mind that under-the-radar funds are not a panacea to superior performance. As ever, investors need to choose wisely.

No shortage of value opportunities

For those on the lookout, there is plenty of choice. The market environment of much of the past decade and particularly the dominance of the mega-cap technology stocks, has left a lot of areas “under the radar”. This continued in 2023, when markets were led by a handful of large companies – the Magnificent Seven in the US and companies such as Novo Nordisk A/S ADR (XETRA:NOVA) and ASML Holding NV (EURONEXT:ASML) in Europe.

This is the first indication of where investors should start looking. The dominance of index heavyweights has flattered the performance of index funds and created momentum. With this in mind, active funds are a more fertile hunting ground for undiscovered opportunities than passive funds.

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James Klempster, deputy head of multi-asset at Liontrust, says: “Markets are paying attention to the fundamentals of individual companies in in a way we haven’t seen for some time. Globalisation had created disinflationary pressures, but that era is now behind us. We are likely to see high interest rates with a greater diversification of interest rate policy and economic outcomes. It is a much richer environment for active managers.”

He says the biggest beneficiary of this shift in the interest rate environment is likely to be income-generative assets. These areas have been widely neglected by investors in pursuit of the growth on offer from exciting areas such as technology. This includes bonds, but also equity income strategies. He believes a growing income is likely to have greater appeal for investors in a higher inflation, higher interest rate environment. This creates opportunities, with the Guinness Asian Equity Income typical of a fund that has been left behind – just £240 million in size and top quartile over three years, it should be more popular than it is. The fund is one interactive investor’s Super 60 choices.

Unpopular areas

While plenty of areas have been neglected in the shadow of the technology giants, the UK has been actively disliked. Since the Brexit vote, around £50 billon has come out of UK-focused funds. Small and mid-cap stocks have been particularly hard hit, with many previously popular funds seeing their assets dwindle.

With the caveat that there are still real problems in the UK economy, there are a number of funds that could see a bounce if there is a shift in sentiment towards the UK. On the Super 60 list, Diverse Income Trust Ord (LSE:DIVI), managed by Gervais Williams at Premier Miton, has been hit hard by its small and mid-cap exposure. It now holds £264 million in assets, having held over £400 million as recently as 2021, but it would be a beneficiary of a revival in small and mid-cap companies.

Value has also been an uncomfortable place to be invested, with funds such as ES R&M UK Recovery seeing assets dwindle to below £200 million. Managed by experienced stock picker Hugh Sergeant, this may thrive in an environment of higher interest rates and greater focus on the characteristics of individual stocks. It is also a member of ii’s Super 60 list.

Elsewhere, the £366 million Artemis UK Smaller Companies fund combines both smaller companies and value. Ben Yearsley, investment consultant at Fairview Investing, says: “This fund is very much tilted towards the value end of the spectrum but will always remain a core strategy in my view. There is a huge emphasis on free cash flow of the underlying companies, rather than earnings growth or momentum. Mark Niznik, the manager, also prefers companies with little or no debt - again this feeds into the core feel of the fund.”

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A similar phenomenon has been evident in Europe. The £181 million MI Chelverton European Select fund also has a small-cap and value tilt. It is a relatively new fund (launched in 2018) managed by experienced stock pickers Dale Robertson and Gareth Rudd. It is a top 10 holding in the CT MM Navigator Boutiques fund, which specialises in finding interesting new boutique managers.

Overlooked

In the US, some investors are starting to direct their attention away from the Magnificent Seven to explore other parts of the market that have been overlooked. Klempster is overweight US small-caps for this reason. The Premier Miton US Opportunities fund, another ii Super 60 pick, has a higher weighting in US small and mid-cap companies and is an option to diversify US exposure.

Another option for a strategic move away from the mega-caps is the Invesco S&P 500 Equal Weight ETF Acc (LSE:SPEQ). Dzmitry Lipski, head of funds research at interactive investor, says: “Currently, the S&P 500 is dominated by the so-called Magnificent Seven largest technology companies that make up almost 30% of the index. This ETF provides equally weighted exposure to US blue-chip stocks that make up the S&P 500 index.

“Every stock in the index is weighted at 0.2%, regardless of how large or small the company is. The fund reflects the US large-cap equity market while taking a size-neutral approach and covers approximately 80% of the available market. The fund’s equal weight approach offers greater exposure to smaller stocks and those with lower valuations, and thus providing a better diversified approach to investing in US stocks, which could lead to potentially higher returns.”

New themes

For investors looking for something undiscovered, the clean energy theme is still in the foothills of its growth path and the Polar Capital Smart Energy fund is a relatively new fund on the block. Lipski says: “Prioritising decarbonisation and electrification in the future energy sector, the fund has a long-term outlook that aims to capitalise from the global shift towards a more sustainable future.”

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It invests across four investment clusters: clean power generation, energy transmission, energy conversion and storage, and energy efficiency, the latter constituting 40%-50% of holdings. Current focal points for the fund include big data, energy efficiency in industrials, and silicon carbide semiconductor materials. Lipski says investors should be prepared for volatility, but this will be an important theme in future.

On similar lines, Yearsley sees structural growth in commodities ahead and picks the WS Amati Strategic Metals fund. He says: “Many commodity companies have been in rude health, but worries about the global economy and China in particular have knocked the sector. This fund is quite unique in that the focus is more on the smart metals, with a pivot to precious metals at certain points in the cycle. Smart metals like lithium have been hammered over the past year. The electrification trade isn’t going away, governments want it, it is just a case of when, not if. This is a long-term strategic holding.”