OK, a week’s movement in the markets and the order could change, but it’s only likely to be a switch between the top two sectors.
There seems to be a renaissance in UK smaller companies and smaller companies globally. Both Standard Life and Schroders have launched global smaller company funds because they see a good opportunity – is this a signal investors should be heeding?
Globally the universe of smaller companies has grown considerably in the past decade and in the UK they are at attractive valuations compared with large and mid-cap stocks. Long-term data shows that smaller companies outperform significantly both large and mid-cap companies but there are periods of extended volatility and periods when they are in the wilderness.
The received wisdom is they are higher risk and that in difficult economic times they are more vulnerable than large-cap stocks. In reality this is an over-generalisation on both counts because there are good and bad companies within all market cap groups or sectors. If an investor can find good quality small companies, with robust balance sheets, in strong market positions, which are profitable then they can survive difficult economic conditions just as well as their large cap brethren. This applies worldwide as well as in the UK.
The other attraction is that small-cap stocks are under-researched. Furthermore, when the investment management industry goes through a tough period, just as it has, then budgets for small-cap research are often cut. On the one hand this is negative, but it is also a positive for those still researching and investing in small caps. The opportunity to find cheap stocks increases.
Longer term the reasons for small caps to outperform remain intact – they are growing from a smaller base; they are often owner-managed; they are frequently in niche markets; and if they are a major supplier in that market their profitability can be significant.
Their potential for growth is key. Large-cap stocks such as Glaxo or Vodafone will really struggle to expand their businesses in a meaningful way and yet in a low-growth world it is these stocks that investors prefer, invariably on the assumption that they are safer.
However, as the economic outlook improves then small caps must surely be well placed to perform.