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Variety of small caps

This article is part of
Guide to Investing in Small Caps

Given the risks of individual small company shares the diversification offered by funds can be of value to investors as it reduces the impact if one company fails. But small cap funds, like those in other asset classes, can vary widely.

Size of funds is a major factor, says Adrian Lowcock, senior investment manager at Hargreaves Lansdown.

“Each manager tends to bring their own style and processes with them and some are more process-driven than others.

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“Performance of funds varies hugely and clearly some managers have the talent to out-perform in this market whilst others do not.”

Geographical differences can be quite marked.

The UK has one of the most developed markets for smaller companies, with the London Stock Exchange’s Alternative Investment Market providing access to start-up companies and the LSE also offering exposure to more highly regulated small companies, with both markets allowing companies to grow to whatever size is possible.

The UK has a significant number of investment trusts in its smaller companies index, Mr Lowcock notes.

In addition, smaller mining and oil exploration companies are a significant feature - and compared with the FTSE 100 and the FTSE 250 there are more tech companies.

The US is the world’s largest small companies market and arguably one of most competitive areas, Mr Lowcock states.

“The US has some of the best infrastructure to provide finance, management expertise and technical knowledge to grow small businesses. The US really knows how to develop small companies into world leaders in their fields.”

Neil Hermon, co-head of UK equities at Henderson Global Investors, points out UK smaller companies are more exposed to the domestic UK market compared to US small caps, for example.

“This means they are less influenced by the ups and downs of global economies and markets.”

While the upper end of the FTSE is dominated by sectors such as banks, miners, oil and gas – many of them heavily focused overseas – Mr Hermon stresses many smaller caps were retailers, support service providers, industrials and technology companies.

“Often, they are innovative, high-tech businesses operating in niche markets with great growth potential.”

Looking further afield, Mr Lowcock says Asia and emerging markets are still in their infancy, though smaller companies are benefiting from improved corporate governance and financing but still some way behind the west.

“However the growth potential in these markets is huge.”