UK small business investment was among the surprise packages of last year’s equity market, posting strong returns that outperformed the large-cap heavyweights.
Amid concerns at the beginning of 2012 that defensive investments would remain prominent in light of ongoing economic turmoil, impressive performances in the small-cap sector helped dispel murmurs of domestic economic stagnation.
As market confidence continues to grow and talk of recovery gains momentum, income-hungry investors, tired of low yields in the fixed-income market, are once again growing more bullish. In fact, many expect 2013 to reward those holding riskier assets, despite ongoing concerns surrounding the US fiscal cliff and eurozone.
Including dividends, total returns for UK equity investors last year were at around 13 per cent, significantly higher than the 4 per cent return of conventional gilts. Even though the overall FTSE indices made up for a disappointing 2011, the biggest talking point was the success of the FTSE Small-cap index, which was up 25.2 per cent on the year.
Growth opportunities within UK smaller company investment have been well documented in the past. Looking beyond talk of illiquid and volatile stocks, advocates of small caps often address the risk-return conundrum by highlighting how in recent years the Numis Smaller Companies index (NSCI) has consistently outperformed large-cap indices and gilts.
If such information wasn’t already enough of an incentive to take the plunge into the risky terrain of UK smaller companies, professors Elory Dimson and Paul Marsh of the London Business School say small caps have outperformed their larger counterparts since 1955.
Their research indicates that total returns from the NSCI have outperformed the FTSE All-Share by 3.2 per cent a year since 1955 and 3.4 per cent a year for the past 11 years. The NSCI, otherwise known as the defining benchmark of the UK smaller company sector, spans more than 800 companies that make up the bottom 10 per cent of the UK market by value.
Graph 1 illustrates the erratic yet far superior growth of the NSCI in comparison with the steadier development of the Barclays UK Equity index. This makes for interesting reading once you factor in figures from the Investment Management Association (IMA), which says the average fund in the UK small-cap sector is up 19.1 per cent during the past 12 months, 5.1 per cent higher than the equivalent UK all companies and UK equity income sector fund.
Banking on recovery
While some may be surprised by the success of small caps last year, historically recessions are often followed by periods when small companies thrive on restored market confidence.
