Investment insight – UK smaller companies

Investing in smaller companies may be considered risky as it generally brings higher volatility levels, but small-caps could offer a way for investors to expand their UK portfolios. Smaller companies also typically grow faster than their mid- or large-cap counterparts.

A sluggish economy has historically meant bad news for smaller companies as they are more sensitive to domestic growth. But now the UK is starting to pick up again and, with a new governor in charge of the Bank of England (BoE), the UK’s economic outlook could be improving.

The rate of the consumer price index (CPI) inflation fell to 2.8 per cent in July from 2.9 per cent the preceding month. The retail price index (RPI) also fell from 3.1 per cent to 3.3 per cent in June. According to the Office for National Statistics (ONS), house prices saw a year-on-year increase of 3.1 per cent in June compared with a 2.9 per cent rise in May.

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Forward guidance

More recently, the BoE warned in August that inflation will remain high for longer than it had previously expected, and growth levels will be weaker for longer. The new governor, Mark Carney, announced in the Bank’s quarterly inflation report that inflation is likely to remain at more than 2 per cent for at least another year – roughly six months longer than was forecast in February’s report. Mr Carney also said the Bank will not raise interest rates until UK unemployment has fallen to 7 per cent or less – it is currently 7.8 per cent. He admitted it could take up to three years.

Mr Carney said the Bank will not cut back on its current £375bn quantitative easing programme. The move is similar to that of the European Central Bank and the US Federal Reserve in what is known as “forward guidance” interest rate policies.

Beyond the UK, smaller companies based here have become increasingly global. A reliance on international revenue streams means they are perhaps not as volatile as once considered.

According to the latest figures from the Investment Management Association (IMA), UK funds were the bestsellers with net retail sales of £479m, the highest figure since October 2006. The month’s sales were also well above the £60m outflows that the funds averaged over the previous 12 months.

June represented the first time since May 2012 that global equity funds have been beaten as the top-sellers, suggesting the UK is back on track. In terms of quarterly net retail sales, UK equity funds secured £857 million for Q2 2013, again the highest it has been since Q4 2006.

Aim small

So how have the UK’s smaller companies funds been faring? To qualify for inclusion in the sector, the IMA says funds must invest at least 80 per cent of their assets in UK equities of companies which form the bottom 10 per cent by market capitalisation.

The government recently decided that investors should now be able to allow Aim shares in their Isas. Aim shares are typically small- and medium-sized companies that are not ready to list on the FTSE, but there are some companies which fall under the smaller company label that are already well-known household names. Majestic Wine, designer Mulberry and online retailer ASOS are just a few of the brands in which individuals could potentially invest.