Fund briefing: smaller companies

Published by Rob Griffin on 10 May 2017.
Last updated on 10 May 2017

Many investors that put their faith into smaller companies funds a decade ago have every reason to crack open the champagne and start celebrating. The majority of funds in the four main Investment Association (IA) sectors that focus on smaller companies have risen by more than 100% over the past 10 years, according to Morningstar data compiled to 19 April 2017.

In fact, the average fund has risen 197% in IA North American Smaller Companies, 130% in IA Japanese Smaller Companies, 114% in IA UK Smaller Companies, and 99% in IA European Smaller Companies.

And the very best performers have done substantially better, with Henderson Horizon Japanese Smaller Companies up 265%, T.Rowe Price UK Smaller Companies having risen 254%, and Marlborough UK Micro-Cap Growth, a member of Moneywise’s First 50 Funds for beginners, delivering 244% – more on this fund later.

The 10-year performance evidence supports the idea that small companies, which are often dynamic firms, have the potential to outperform larger companies over the long term – particularly those at the consolidation stage of their development. This is a stage in the life of a company at which it is able to merge product lines, or may consider merging with another company in the same industry.

However, small companies can also be more volatile than larger companies and tend to fall further and faster when markets go down and investors shun risk, warns Patrick Connolly, a certified financial planner with Chase de Vere.

“Investing in smaller companies funds is more suitable for higherrisk growth investors who want the potential of better returns and are willing to accept greater levels of volatility and potentially significant short-term losses in order to achieve this,” he says.

He suggests the best approach may be to invest in a combination of large companies, which can provide greater security to the overall portfolio, and small companies that boast better longterm growth potential, albeit with more volatility.

According to Adrian Lowcock, investment director at Architas, the main benefit of investing

in a smaller companies fund is getting access to stocks that can exploit niche areas that may be overlooked by larger firms. There’s always the prospect of investing in the next Microsoft.

“They are also higher risk and, more often than not, don’t grow into large companies and either stay small or collapse,” he points out. They can also be very volatile, particularly in sectors such as oil exploration and biotech where stocks rise and fall as the result of rumours.

“Of course, the prospects for smaller companies in different parts of the world can vary enormously depending on the economic backdrop and the performance of local stock markets, as well as issues affecting individual sectors and companies.

“The UK market has a great reputation with lots of exceptional managers who can add value through stock selection and portfolio construction, while Japanese small caps have traditionally been very volatile and will rise or fall quickly,” he says.

The US market, meanwhile, is huge and active fund managers find it's a tough market in which to generate returns that beat the index. Mr Lowcock points out that “US small caps would benefit from the fiscal stimulus Trump has promised”.

Unsurprisingly, given the fact that people generally favour their home market, the IA UK Smaller Companies sector is the most popular with domestic investors who have committed £13.2 billion in funds under management.

It continues to be popular. The latest figures published by Morningstar reveal that £44 million of net retail sales made it into this sector during February 2017, with £14 million in IA US Smaller Companies and £7 million into IA Japanese Smaller Companies.

One of the favoured UK-focused portfolios is Marlborough UK Micro Cap Growth. Mark Dampier, research director at Hargreaves Lansdown, which includes the fund on its Wealth 150+ list of preferred funds, considers Giles Hargreave – one of the fund’s co-managers – to be one of the most experienced and successful UK smaller companies fund managers.

“Strong stock-picking has been the main driver of this performance, according to our analysis,” he says.

“Giles Hargreave conducts detailed analysis of individual companies to understand in detail what they do and how they make money.”

Mr Dampier brands the fund’s outperformance of the FTSE Small Cap index as “exceptional”, pointing out it invested in some of the UK’s smallest listed companies. “We view this as an under-researched area where shrewd fund managers have the opportunity to add significant value for investors over the long term,” he adds.

So what do the prospects look like for smaller companies funds? Well, no one has a crystal ball but Mr Lowcock is hopeful for decent returns over the coming months, despite the economic and political uncertainty around the world.

“If economic growth continues and we get some fiscal stimulus, then small caps should benefit – but they will also fall significantly in times of stress or recession so investors should look to hold them for at least 10 years,” he says.



Fund to watch: F&C Global Smaller Companies PLC

This investment trust, which was launched in 1889 and is managed by Peter Ewins, aims to secure a high total return by investing in smaller companies across the world.

As the largest specialist global smaller companies investment trust at £752.1 million, it seeks to exploit the fact that many of these companies aren’t widely researched and can often grow faster than more mature, larger names.

The trust consists of around 200 holdings, including 10 funds that target markets where F&C doesn’t have dedicated in-house smaller company expertise. These include Aberdeen Global Asian Smaller Companies and Eastspring Investments Japan Smaller Companies.

The largest geographical exposure in the fund is the 43% in North America, followed by 25.7% in the UK and 10.8% in continental Europe. The rest of the world is next with 10.7%, followed by 8.4% in Japan and 1.4% in cash and fixed interest.

In his most recent commentary, Mr Ewins points out there had been underperformance in his US holdings, with weakness in several stocks. ATN, the telecommunications services company, for example, fell after announcing weak results.

Elsewhere, the trust enjoyed outperformance from the UK and Europe. The UK portfolio was lifted by strong rises for a number of stocks, including specialist ingredients supplier, Treatt, which announced sales and profits were running ahead nof expectations.

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