Killik & Co downgrade Investec UK Small Cap fund to ‘sell’

Killik & Co has downgraded the £470m Investec UK Smaller Companies fund from ‘neutral’ to ‘sell’, following concerns over possible redemptions as a result of the fund size as well as issues with underperformance and stock selection.

The advisory stockbroking and investment service issued a note saying it had downgraded the fund as part of its recommendations.

Killik & Co head of research Mick Gilligan says that while UK smaller companies have continued a strong run throughout 2012 and into 2013, the relative return of the Investec fund “began to wane” at the end of 2012.

He adds: “This relative underperformance trend has continued into 2013 and has prompted us to review our recommendation.”

An overweight position in mining partly impacted the relative return of the fund in 2012, according to Gilligan. He says: “The FTSE Small Cap mining sub-sector fell 38 per cent.

“Although the mining exposure in the Investec fund fared much better at -3 per cent, the larger average weighting of (7 per cent versus index weight of 2 per cent) was clearly unhelpful.”

Poor stock selection year to date has also been negative in more than half the sectors the fund invests in, says Gilligan. He adds: “This poor stock selection has led to the fund underperforming the index and the peer group.”

The fund is ranked 7th in a sector of 51 UK Smaller Companies funds over the five-year period to the end of June. Gilligan attributes this to the fund’s “good long-term performance.”

However he adds that this performance has attracted strong capital inflows, causing the fund size to “swell” close to half a billion worth of assets at the end of January 2013.

Gilligan says that although it is “unclear” whether the larger size is leading to deterioration in performance, the decline in relative performance coincides with a reduction in portfolio turnover levels.

Morningstar data shows a 35 per cent decline in portfolio turnover in the latest 12 month period also implies that the fund has been experiencing net redemptions, argues Gilligan.

He adds: ”One potential drawback of successful funds is that they grow in size to the point where portfolio flexibility is hindered and performance starts to suffer. This is of particular importance to smaller company funds, where underlying stock liquidity can be more of an issue.”

Investec declined to comment.