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As the markets experienced a wholesale shift away from small caps in favour of the liquidity and perceived security of large caps, it should come as no surprise funds within the IMA European Smaller Companies sector struggled over the past year.

In all, the average fund in the sector fell by 13.9 per cent on a cumulative basis over one year to 16 June, according to Morningstar. This compares unfavourably with the average performance for rival sector IMA Europe excluding UK, which, although suffering a loss, only fell by 6.7 per cent over the same period.

What is more surprising is the recovery funds within the sector have staged, returning 4.9 per cent over three months, marginally outperforming Europe excluding UK’s 4.8 per cent. This is more in line with the longer-term trend of the outperformance of the funds biased towards the smaller end of the capitalisation scale, with cumulative performance over three years of 57 per cent, compared with 48.4 per cent for Europe excluding UK.

Funds in this tiny sector – it currently has 16 funds under its umbrella – have it within their remit to invest in the UK, although this exposure must not exceed 80 per cent of the total portfolio. However, the top performer over one year – the £4.3m Baring Europe Select fund – does not have any direct holdings in the UK, preferring to invest in “growth at a reasonable price” in mainland Europe.

Manager Nick Williams secured strong performance over the latter half of last year, cementing his predominant strategy of opting for stocks at the larger end of the small to mid-cap scale. He also moved the fund away from the more concentrated style he favoured when he took the reins three years ago, moving up from around 70 to over 100 holdings.

According to a review of the fund by Standard and Poor’s, he also “demonstrated a disciplined use of price targets, most notably in last year’s volatile market conditions when he shrewdly sold his exposure to building materials early in the year and sharply reduced his exposure to financials on grounds of valuation, ahead of the credit crisis”.

The story of Mr Williams’ success is a good lesson for the other funds in the sector, with an emphasis on adapting to market conditions quickly and sticking steadfastly to the sell discipline. In as broad a universe as this sector covers, with lots of new stocks jostling for position, these are both important qualities for managers to possess.