Fund Briefing: how to invest in US smaller companies

14 November 2018

Investors who put their faith in the IA North American Smaller Companies sector have every reason to be cracking open the champagne.

The IA North American Smaller Companies sector has been the best performer over the past year, with the average fund returning an impressive 24.60%, according to Morningstar Direct.

This puts it comfortably ahead of the other 31 sectors, only five of which made it into double figures, while seven were mired in negative territory.

Ben Willis, head of portfolio management at Chase de Vere, attributes much of its success to the strength of the US economy.

“Stock market returns have been buoyed by strong corporate earnings numbers, positive sentiment, and expectations about the prospects of US companies,” he explains.

He believes a strong dollar, President Trump’s tax cuts, investors returning to their home market, and global investors chasing growth would be supportive for US smaller firms.

However, he warns smaller companies in the UK could suffer if the dollar weakens or investors conclude the US stock market is too expensive and look for opportunities elsewhere.

“Smaller companies are more volatile than larger ones and tend to fall further and faster when markets go down and investors shun risk,” he explains.

The IA North American Smaller Companies sector is for funds that invest at least 80% of their assets in companies forming the bottom 20% by market capitalisation.

It is relatively small with less than 20 funds, which is one of the reasons it accounts for just £2.7 billion of UK investors’ cash.

In comparison, £58.6 billion has been invested in the IA North America sector, whose funds focus on larger US organisations, and a whopping £183.7 billion in UK All Companies.

As the US has the world’s largest economy and stock market, it should be part of every investor’s portfolio, according to Adrian Lowcock, head of personal investing at Willis Owen.

The main decision is what type of exposure makes sense. He suggests a core US fund that is diversified across small, medium and large companies.

“Smaller companies will come in once an investor has established a diverse portfolio across the main asset classes and is looking to complement their existing exposure,” he says.

Investors with more broad-based equity funds may find they already have some US smaller companies within their overall portfolio and may not need more exposure.

“The risks can be significant but the potential growth is huge”

“Smaller companies are dangerous and the risks can be significant,” he says. “However, the potential for growth is huge and can offset the risks if you invest wisely.”

It is also worth pointing out that smaller companies have done well since the global financial crisis a decade ago, according to Ben Yearsley, director of Shore Financial Planning.

“Small cap goes in and out of fashion, but I think it should form an integral part of long-term portfolios,” he says.

In particular, he notes technology firms – many of which hail from the US and initially operate as smaller companies – have been among the biggest winners in recent years.

“If you go back to 2008, technology was still a largely unused asset class as many investors were still smarting from losses from the tech bubble in 2000,” he points out.

Technology is clearly a significant part of many portfolios. For example, it accounts for 12.7% of assets under management in the JPM US Small and Midcap Companies fund.

Its largest holdings include names such as Bottomline Technologies, which helps businesses make and collect payments across borders, currencies and industries.

There is also Acxiom, which provides data, connectivity and services to help with companies’ marketing requirements. All such firms are at the cutting edge of developments.

This is why you need to choose a fund where the manager has demonstrated considerable skill in picking individual stocks that have the potential to be stars of the future.

“Small cap should form an integral part of long-term portfolios”

Darius McDermott, managing director of Chelsea Financial Services, highlights LF Miton US Opportunities fund, which has a sizeable allocation to small and medium-sized companies.

“The managers of this fund focus on companies that have a sustainable competitive advantage versus their peers,” he explains.

Then there is Hermes US SMID Equity, which invests in US small and medium-sized companies that are underneath Wall Street’s radar.

He points out that its manager, Mark Sherlock, looks for quality businesses with minimum debt, in industries with barriers to entry, or products/services that can’t easily be replicated.

“Against a market notoriously difficult to beat, Mark Sherlock has built an enviable track record, outperforming the average US equity fund and the index consistently over the years,” he adds.

Cormac Weldon

Fund to watch: Artemis US Smaller Companies fund

Cormac Weldon, the respected head of the US team at Artemis, has managed this fund since its launch four years ago.

The fund, which typically holds 40 to 60 stocks from a universe of more than 2,000, favours companies with market values below US$10 billion.

In his latest fund update, Mr Weldon said he sees opportunities within healthcare and recently bought a holding in STAAR Surgical. “It makes implantable contact lenses to treat refractive disorders such as myopia,” he said. “These lenses are an alternative to corrective laser surgery,” he said.

The fund has also invested in firms benefiting from the legalisation of marijuana, mostly for medical use.

“Canada was an early mover in approving marijuana for both markets, so Canadian companies are at the forefront of the trend,” he added.

Legalisation poses both a threat and opportunity to pharmaceutical and drinks firms. While marijuana may be seen as a rival product, companies in these industries recognise its financial benefits. For example, Constellation Brands, which makes Corona beer, recently increased its investment in Canopy Growth, the cannabis company.

“Marijuana can be an extremely effective treatment for some less common ailments (such as severe epilepsy) but also for broad-based pain relief,” wrote Mr Weldon.

Ben Willis of Chase de Vere says: “Cormac Weldon and his team have an excellent pedigree of investing in US Smaller Companies, establishing a strong track record of investing through the cycle.”

Value of £100 invested in the fund over five years

Fund percentage movement in year (%)-10.7511.629.5527.08
Value of £100 ** (£)-110.75154.01171.88218.41

* To 27 September 2018 **The £100 was invested on January 1 2015.
Source: Morningstar

ManagerCormac Weldon
Launch date27 October 2014
Total fund size£497.7 million
Minimum initial investmentDepends on the platform
Maximum initial chargeDepends on the platform
Annual management charge0.75%
Performance feeN/A
Contact details for retail

Rob Griffin writes for the Independent, Sunday Telegraph and Daily Express

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