Patrick Connolly, Certified Financial Planner at Bath-based Chase de Vere Independent Financial Advisers, says over most reasonable periods it is likely that smaller companies will outperform larger companies.
Mr Connolly says: “In the UK smaller companies have typically out-performed their larger brethren by around 3.5 per cent per annum.
“However, investors must be prepared to accept high levels of volatility when investing in smaller companies, which can suffer large downturns in adverse market conditions as we witnessed in 2008 when UK Smaller Companies stocks fell by over 40 per cent.
“The illiquid nature of smaller company stocks pushes prices down too much as investors seek security in more difficult times, but the bounce back can be swift when sentiment recovers as demonstrated by returns of over 50 per cent in 2009 and 30 per cent in 2010.”
“Some investors won’t want to take the risk of investing directly in smaller companies funds. They can either avoid the sector altogether or get more limited exposure through broad-based UK equity funds, which will invest in a combination of large, mid cap and small companies. A suitable fund could be Artemis UK Special Situations.”
A fund’s performance will depend on the fund managers’ style and process, says Steve Kenny, head of retail sales at Kames Capital.
Strategies that focus on quality businesses might limit the downside in falling markets, but Mr Kenny says thesemay also underperform in strong bull markets. Market momentum-style funds will do the opposite.
A full understanding of the investment process and the style of the manager is therefore crucial, Mr Kenny says.
The long-term share price performance of individual companies is primarily determined by how successful the individual business is in terms of growth and cash generation, says Catherine Stanley, manager of the F&C UK Smaller Companies fund.
Over shorter periods however, Ms Stanley says other factors can make themselves felt.
She says: “Smaller companies as a grouping tend to perform well when the economy is expanding – corporate and consumer spending is likely to be on the up and investors are more willing to invest in asset types that are perceived to be ‘riskier’.
“During more difficult economic times the reverse happens and they commonly lag the shares of larger companies, whose operations are considered to be more resilient.
“Following the credit crunch and the resulting downturn smaller companies fell sharply. When signs of recovery began to emerge, however, they posted a significant recovery.”
