Large-cap companies might be viewed as the bellwethers of the economy, but it is the smaller firms that offer the greatest potential growth for investors who are patient.
Some of the biggest and most successful global brands started with next to nothing in a garage – think Apple, Mattel and Amazon. Their success is a testament to the fact that the smaller end of the market cannot be ignored.
In the UK, small-cap companies, which represent the bottom 10 per cent of firms by market capitalisation, have shown an incredible run of performance recently. In 2012 the Numis Smaller Companies index returned 29.9 per cent compared with 12.3 per cent for the FTSE All-Share. Since 1955 it has generated a compound return of 15.5 per cent as opposed to 11.9 per cent for the FTSE All-Share.
There is no shortage of good quality smaller companies funds investing in the UK, but when it comes to making a global allocation, the options for investors are less plentiful. There are dozens of funds that might focus on Europe, the US, Japan or Asia Pacific in general, but only a handful that do it all. Nevertheless, the argument for investing in a global smaller companies fund is strong.
Look no further than the performance of two global indices since markets bottomed out more than four years ago. Since hitting a low point in March 2009, the MSCI All Country World Small Cap index has increased by 163 per cent. Meanwhile, the MSCI World Large Cap index gained 93 per cent in the same period.
While small-cap companies are generally riskier than large- and even mid-cap firms, the potential for growth is much higher and, in the case of those operating in developed markets, they can be less risky than emerging markets equities.
Hundreds and thousands
During the global economic downturn, smaller companies went through their fair share of pain, seeing share prices tumble and profit margins narrowing. And while they might offer great growth potential, small-caps often come at a price premium with price-to-earnings (p/e) ratios, which tend to be higher than those for large-cap firms.
Isabelle de Gavoty, head of small-cap investment at Axa Framlington and a manager on the recently launched Axa WF Framlington Global Small Cap fund, says the price premium for small-caps is not as high as it was in 2007, but it has not gone away either. “I’ve barely seen a year when I have not seen small-caps at a premium,” she says.
