Talking Point  

Recession is 'testing time' for small to mid-caps as IFAs favour their larger peers

Recession is 'testing time' for small to mid-caps as IFAs favour their larger peers
Shell is an example of a large cap company (credit: Andy Rain/EPA-EFE/Shutterstock via Fotoware)

With the UK entering into a recession advisers say they are more likely to increase their allocation to large caps, according to the latest FTAdviser poll.

The poll which asked advisers: amid the market uncertainty, are you more likely to increase your allocation to UK large, mid or small caps?

Half of those who responded (50 per cent) said large caps, 30 per cent said mid caps, while 20 per cent said small caps.

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Tim Morris, IFA at Russell and Co, said, it was not surprising to see that large caps were more favoured. 

“As we enter a recession, the economic environment for small and mid caps will become more squeezed,” he added.

The main reasons he gave for this were that: 

Small and mid caps tended to have less pricing power - therefore less scope to increase prices in the face of rising costs. This will squeeze profit margins. At the same time, consumers will reign in their spending and buy less. 

Secondly, small and mid caps would find it difficult to borrow money to expand and help them grow as the economy recovered.

“And yet by the time a recession is announced, we are often through the worst of it. So they could actually start to grow shortly after we enter recession - the caveat being how deep and prolonged the recession is,” Morris added.

Finally, more small businesses fail. 

Morris said: “We have already seen a steep rise in company liquidations in recent months. Many will be severely tested. However, those that survive could well go on to thrive. That's when we will see the real winners. 

“Buffet painted a vivid picture with his assessment of this; 'when the tide goes out, you find out who's been swimming naked’.” 

One disadvantage for UK large caps, though - Morris noted - was the impact of rate increases slowing sooner in the US - mainly because the US looks likely to have inflation under control sooner. 

“In addition, if rates here continue to increase or stay higher for longer, we could see the pound strengthen against the dollar. That can erode the value of overseas earnings - much of which are in dollars for large multinational companies,” he added.

Following the Autumn Statement, markets were largely unmoved, with both the FTSE 100 and the pound barely reacting, but investors have warned that the government may have "overcorrected" from the debacle of the "mini" Budget, which could lead to growth being stifled.