Exceptional returns from Britain’s small firms

Despite the gloom surrounding the British economy, David Horner, co-manager of the Chelverton UK Equity Income Fund, is bullish about UK small caps. The £36.1m fund invests in high-yielding stocks from the bottom tenth of the stockmarket 64 of the 71 stocks have a market cap below £1bn.

The fund's three-year performance is "exceptional", says Patrick Collinson in Fund Strategy. It is up 66% over the period, compared with the 35% gain for the average UK equity income fund, placing it second out of 98 funds in the sector. "Small companies are very profitable and generating a lot of cash," Horner tells Fund Strategy. "They started repaying their debts five years ago and many have built up a lot of cash, with some paying special dividends, such as Micro Focus and Moneysupermarket.com."

Other favoured stocks include Dairy Crest (yielding 6%) and specialist distribution services firm Diploma, which raised its dividend by 39% in 2008, 4% in 2009, 15% in 2010, 33% in 2011 and recently by 20%.

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With its focus on smaller caps, the portfolio "bypasses" the traditional income stalwarts of the FTSE 100, says James Smith in Money Marketing. However, as co-manager David Taylor argues, the fund offers the diversification that larger-cap funds in the sector often lack. "The vast majority of these funds generate their income from just a handful of companies, which is a big risk if one has to cut its dividend," Taylor tells FE Trustnet. "All of our stocks contribute and none make up more than five per cent of the total dividend."

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Chelverton UK Equity Incometop ten holdings