(Bloomberg) -- For investors in U.K. stock funds last year, the biggest returns came from thinking small.
The best-performing U.K.-focused funds made their money by snapping up smaller companies, led by a Premier Miton Group Plc fund that soared 77%, according to Morningstar Inc. data. The average gain across such investments was 6.8%, while rivals that bet on mid-sized and large companies mostly lost money as the pandemic battered the economy.
Small companies were going cheap for much of 2020, after a four-year investor exodus following the Brexit referendum drove down the values of even healthy firms. That created the potential for dramatic gains, led by technology, biotech and medical firms that surged as the outbreak and government lockdowns pushed up demand.
“The valuations of small-caps hit rock bottom and had more recovery potential,” said Gervais Williams of Premier Miton, who manages the top-ranked fund with Martin Turner. “With the end of Brexit, there’s greater scope for some of these domestic companies.”
The performance of the 106 million-pound ($145 million) Premier Miton fund was boosted by wagers on companies that thrived during the outbreak, such as Synairgen Plc, a pharmaceutical firm whose shares skyrocketed thanks to its development of a Covid-19 treatment, Williams said. The fund was also lifted by its stake in digital privacy firm Kape Technologies Plc, which benefited from the surge in people working from home.
The second-ranked U.K. small-cap fund, co-managed by Richard Power at Octopus Investments Ltd., saw returns of nearly 35% driven by bets on companies including Ceres Power Holdings Plc, a developer of hydrogen fuel-cell technology, and EKF Diagnostics Holdings Plc, whose products include a Covid-19 test.
The Premier Miton and Octopus funds don’t invest in small unlisted companies, the strategy that helped bring about the downfall of once-famed stock-picker Neil Woodford in 2019. Regulators have stepped up scrutiny of money managers after liquidity crunches at Woodford’s funds and H2O Asset Management highlighted the risks of funds that hold hard-to-sell assets yet allow investors daily access to their cash.
Looking ahead, the U.K.’s trade deal with the European Union paves the way for less economic disruption than could have resulted from a messy split as well as a stronger pound, according to Tim Craighead, senior European equity strategist at Bloomberg Intelligence.
While this should give a lift to smaller British companies, they remain vulnerable to a further economic downturn with the virus still rampant and Prime Minister Boris Johnson warning that his government may be forced to tighten lockdown measures if people fail to follow the rules.
“Smaller caps are more susceptible to possible winter corrections from negative Covid news, especially if the pound reverses course,” Craighead said.
Premier Miton’s Williams said his fund has trimmed its holdings of tech stocks and is now focusing more on commodities firms and miners. Its biggest holding is Jubilee Metals Group Plc, which produces metals recovered from mine tailings and other waste. Another example is Kenmare Resources Plc, which makes titanium dioxide used in plastics and paints.
Like Williams, Power at Octopus sees small-cap funds having another good year.
“A big driver will be a lot of capital coming back into U.K. equities,” he said. “There have been significant outflows since the referendum in 2016. That money is going to come back to the U.K. this year, and a big proportion of it will head down the market-cap scale.”