Are smaller companies coming back into investors’ favour?
The domination of big business, particularly Big Tech in the United States, has been the primary feature in the past decade, encouraged by the trend to index/passive trading.
However, it was not always thus with some suggesting it is the minnows’ moment again as astute share buyers build them into diversified portfolios.
Few fully appreciate that such firms have historically produced lucrative long-term returns via superior earnings performance, finance injections can stimulate worldwide growth in the sector, while entities designated small in the US are often very sizeable indeed by UK standards.
Commenting on small firms’ recent woes, Charles Stanley notes: “The UK has been the most unpopular sector in an extremely unpopular market. While there has been some recovery, this is more a function of the weakness of UK large caps, than a notable change of heart from investors.”
Nevertheless, best not get too caught up in the smoke and mirrors that have – perhaps unfairly – adversely affected the image and rating of smaller companies.
Investors Chronicle states: “An overweight exposure to smaller companies has been one of the more reliable investment strategies in generating higher returns over time, relative to the wider market. Figures suggest that, since 1955, the Numis Smaller Companies Index, excluding investment companies (NSCI), which represents the bottom ten per cent of the UK market, has beaten the FTSE All-Share on average by over three per cent a year on a total return basis. While the FTSE 100 has made little progress since 2000, the NSCI has risen over two-and-a-half times.
“There is an inherent logic to this. Elephants do not gallop. Many smaller companies operate in niche and growing markets, are nimble and exhibit faster growth in part because they are benefiting from the advance of technology. This is not just helping to reduce costs and open new markets, but is better enabling them to embrace the disruptive practices needed to compete with their larger brethren. There is no reason to suggest this will not continue over time.”
Investing in smaller firms enjoys other advantages.
Smaller companies, particularly in the UK and US, can derive a significant proportion of revenue overseas hence are not reliant on their home economy for growth.
Additionally, the benefit fund managers can offer investors in creating portfolios of smaller companies, given research is not as readily available compared to larger companies, is significant. Fund managers undertake greater proprietary research and actively manage portfolios which can add real value for investors.
Kepler hints we are on the cusp of change.
It predicts: “Fears of ‘higher for longer’ interest rates have weighed on small-cap valuations across the board, with a torpid domestic economy further adding to the woes of UK equities.
“However, with macroeconomic issues beginning to ease, contrarian investors may see current valuations as a highly attractive opportunity to position their portfolio for a potential recovery in UK small-caps.
“Investors will be focusing on the catalysts. One such could be a narrowing of the disconnect between investor sentiment and company fundamentals. Roland Arnold, portfolio manager of BlackRock Smaller Companies remarked in a recent note: ‘Many smaller companies have enhanced their competitive position, strengthened their balance sheets and continued to generate volume growth in sales, but this has not been reflected in share prices’.”
As legendary investor Warren Buffett once said: “Most people get interested in stocks when everyone else is. The time to get interested is when no one else is. You can’t buy what is popular and do well.”
Time for small firms to bask in the limelight again? We shall see.