Most investors buying smaller companies funds do so to access early-stage businesses yet to be discovered by the wider market. This is the preconception at least. In reality, many smaller companies portfolios share a number of the same holdings, many of which are well above the market cap most investors expect.
Some British companies such as Gamma Communications, 4imprint and CVS appear in the top holdings of a number of UK small-cap funds, despite it being a broad investment universe. Not to mention, each of these companies have a market cap in excess of £1bn – not the price range most people have in mind when they picture smaller companies.
In the Rockwood Strategic trust, manager Richard Staveley will only invest in companies below £250m to keep the focus on this lower end of the market.
He says: “This industry can sometimes not think about the real world. They are telling the truth in that they are the smallest companies in relation to the largest ones. But in the real world, they are not really small.”
See also: UK small caps: Depressed for a reason, or at the cusp of a multi-year supercycle?
Indeed, the definition of what a smaller company is can vary considerably from manager to manager.
“There is no agreement on what small is – it is all relative. I don’t think there is a mis-selling scandal here, but funds must be transparent about the average size of the companies they are invested in.”
A shrinking market
A key reason why these funds have ended up holding the same stocks is because the number of smaller companies in the UK is shrinking. Valuations were spread more evenly across the market when the Numis Smaller Companies index first launched in 1987, but widespread M&A activity has meant much of the wealth is now concentrated in fewer names.
For example, the largest company in the bottom 10% of the market was worth £108m in 1987. Today, that same company has a market cap of £1.7bn.
To read more visit the February edition of Portfolio Adviser Magazine