Over 2015, the FTSE 100 was down 1.3 per cent, while the FTSE Small Cap ex IT index gained 13 per cent.
Investment Association sectors tell a similar story. The IA UK Smaller Companies sector generated an average return of 14.9 per cent in 2015, while the IA UK All Companies sector managed a more modest average 4.9 per cent return.
Patrick Enright, a research analyst at Financial Express, says it is not hard to see why small caps outperformed their larger counterparts last year.
“Underperforming mining and energy companies sent the FTSE 100 index tumbling down from May onwards, while the FTSE Small Cap (ex IT) was far more resilient, managing to achieve modest growth,” he points out. “Given their greater exposure to the domestic economy, smaller companies were able to ride an uptick in UK consumer confidence, aided by loose credit, low inflation and rising wages.”
Nonetheless, smaller firms attract fewer investors. The IA UK All Companies and the IA UK Smaller Companies sectors recorded net retail sales outflows in the first half of 2015 – but when they began attracting retail sales again in the second, the net figure for UK Smaller Companies peaked at £68m in November; for UK All Companies, it was £303m in July.
Mr Enright notes: “Of the more than 300 funds in the IA All Companies sector, very few are actually sector or market-cap specialists, and so have little exposure to UK equities. The slowdown in China, combined with geopolitical risks and collapsing commodity prices, has made global markets uneasy about the health of larger companies.
“Falling demand for exports is one consequence of a downturn in emerging markets, and so those companies who derive a significant proportion of their revenues from outside of the UK have been negatively affected as a result.”
So, will it be the same this year? With the FTSE 100 dropping into bear market territory on January 20, it will surely not be too difficult for UK small caps to deliver another relative period of outperformance.
Henry Lowson, manager of the Axa Framlington UK Smaller Companies fund, says: “Because they tend to be much earlier stage, much less mature, they can often grow irrespective of what’s going on in the macro economy.” But, he warns: “If money starts to come out the market, that will affect smaller companies from a valuation perspective, irrespective of what their earnings are doing.”
Another boon for UK small-caps is investors’ ability to hold Alternative Investment Market (Aim) stocks in an Isa.
Mr Enright says: “The decision to allow Aim stocks to be traded in Isa accounts has no doubt given investors a newfound impetus for taking on more risk. With some FTSE 100 companies electing to cut their dividends following poor earnings growth, investors choosing to instead diversify their portfolios into smaller companies have benefited from high growth companies that are far more flexible to the macroeconomic environment.”
Schroder UK Dynamic Smaller Companies
This £520m fund is the third best-performing in the IA UK Smaller Companies sector in the 10 years to January 20, delivering 222 per cent over the period against the sector average of 112 per cent. Paul Marriage and John Warren co-manage the fund and had 57 holdings in the portfolio at the end of December 2015. Among its top 10 positions are Fever-Tree Drinks and Smart Metering Systems. Companies in the £250m-£500m range account for 26.2 per cent of the portfolio, while those with a market cap less than £250m make up 58.5 per cent.
Hermes UK Small and Mid Cap Companies
David Stormont runs this £222m fund, which is an Investment Adviser 100 Club 2015 member. It has clocked up consistent returns since it launched in December 2008 with the aim of delivering capital appreciation by investing in small and mid-caps identified as undervalued. In the five years to January 20, it returned 84.4 per cent, compared with the peer group average of 58.1 per cent, FE Analytics shows. Financials account for 25.6 per cent of the portfolio, closely followed by industrials at 24.5 per cent.
Strategic Equity Capital
This investment trust was the winner in the UK Smaller Companies category at the 100 Club 2015 Awards. It is run by GVQ Investment Management, and manager Stuart Widdowson has been responsible for the portfolio since June 2009. The trust is not constrained by market indices and is run to maximise returns for investors over the medium term. In the five years to January 20, it delivered a 150 per cent return to investors, while the AIC IT UK Smaller Companies sector generated 74.6 per cent on average. The portfolio’s three largest holdings are Servelec Group, e2v technologies and Wilmington Group.