Small Caps  

Insight: US small-cap funds plough onwards

  • Understand how North American equities have performed
  • Grasp the drivers behind this performance
  • Gain an understanding of the headwinds facing US small-caps
Insight: US small-cap funds plough onwards

North America – and the US in particular – has been a real hotbed for investment returns in recent times. With the bull market now entering its eighth year, those who have remained loyal to US stocks since the 2008 financial crisis have been richly rewarded.

Things could be about to change after a renewed surge pushed a number of indices to fresh record highs. Concerns over a possible pullback have increased with new president Donald Trump struggling to make the legislative impact that his campaign promised.

The S&P 500 hit an all-time high of 2,396 points on 1 March – the same day as Trump’s first congressional speech – but has since experienced a gradual decline. It remains to be seen whether this slip reflects a temporary lull, or the start of a longer-term drop.

Research from First Trust Portfolios indicates that the average bull market since 1926 has lasted for 8.9 years, which suggests the current run may be near an end. But averages, by design, must be surpassed much of the time, as the near-13 year rally after the 1987 Wall Street Crash demonstrates.

Either way, investors in North American Smaller Companies funds will be watching closely. These portfolios have been among the biggest beneficiaries of the rally. Unlike their larger-cap peers, they have also proved more capable of beating their benchmarks.

Tale of two halves

According to the Investment Association, in order for a fund to qualify in the North American Smaller Companies sector, at least 80 per cent of assets must be invested in companies on the continent that occupy the smallest 20 per cent of the listed stock universe by market capitalisation. 

With total funds under management of £2.4bn, it remains one of the smaller sectors, which is perhaps understandable because of the increased risk in small-caps and its niche focus.

When analysing net retail sales over the past 12 months, some interesting trends are revealed. From February to July 2016, total net outflows were £22m. Although this can largely be centred on £30m exiting the sector during February and March, it was still in keeping with overall investor trends as total outflows for all equity sectors totalled £411m. 

The Brexit vote in June 2016 provoked many investors to abandon equity markets and total net outflows for all equity sectors rocketed to £2.8bn. However, North American Smaller Companies held favour among the turmoil, as the sector was one of only two – the other being Japan – to attract net retail sales during the month. 

The second half 2016 brought with it better sentiment in general, and US small-cap funds were again an area of investor interest. From August 2016 to February 2017, total net retail sales for the sector were £185m. 

The Trump effect appears to be a key factor, as £180m poured into North American small-caps between November to February. Despite the sector’s small size, £78m of this total was invested in November alone, making it the sixth most popular equity asset class out of 19.

Taxing time

Have these investors come in too late or are there more excess returns to be garnered?