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The sector, which has the second-best return of any IMA group over five years to 31 May, has lost 11.8 per cent over the past 12 months. To put that in context, just three sectors fared worse: the financials-heavy UK Equity Income sector, UK Smaller Companies and Japan Smaller Companies.

The last time Analyst addressed the sector, it was ripe for a downturn, but it was impossible to have anticipated the huge amount of panic-driven selling of high-risk assets that was precipitated by the sub-prime crisis. Nevertheless, the downturn provides a useful lesson: while the market had focused on the valuation risk embedded in small-cap shares relative to historic norms, it was their liquidity risk that ended up making the situation as bad as it was. When you are running a large sum of money and need to get out of relatively less liquid names in a hurry, you are going to take a hit. The evidence from portfolios in the sector is reasonably clear on this point: the funds at the bottom of the charts over the past years tended to have sub-£1bn market capitalisations, and the worst had sub-£500m market caps. The funds that held up best tended to have average caps substantially in excess of £1bn.

The sector, like all in the IMA system, suffers from the trade group's focus on serving its member firm's commercial interests rather than providing investors with a real peer group of investable funds. Because it is artificially constrained to UK-domiciled funds run by IMA member firms, it contains just 16 offerings, many of which are not particularly good. Within these constraints, however, a few funds are impressive. JPM Europe Smaller Companies posted a middle of the pack loss over the past year, but that is not bad considering how well it has fared during better times. Moreover, the fund benefits from highly experienced management and a reasonably well-diversified portfolio, although investors need to be aware of its sizable industrials stake.

Dan Dudding's Threadneedle European Smaller Companies is also good. It too features a large industrials weight, but these tend to be oriented towards Asian economies rather than Europe, which provides a degree of additional diversification, and their economic sensitivity should be offset to a degree by the fund's overweight in the relatively defensive healthcare arena. We are a bit concerned by the fund's size, but Mr Dudding has a reasonably large pool to fish in, and it does not appear to be a problem at this juncture.

At the other end of the spectrum, it is difficult to see why Melchior European Opportunities continues to exist. It is costly, has delivered exceedingly poor performance, and has almost no assets to speak of. Further, although it is in the European Smaller Companies sector, it benchmarks itself against the broad MSCI Pan European index and carries a performance fee for beating the benchmark. Given that the index is large-cap orientated and has less than 1 per cent small caps, it makes no sense as a benchmark for a small-cap fund. The fund's performance fee is thus likely to hinge more on the performance of small caps versus large caps than on management skill, which rather defeats the purpose.