The FTSE Small Cap (ex IT) and AIM indices have stalled somewhat of late, the latter having fallen more than 10% since the start of the year. Still over five years, investors have little to complain about with the average fund in the IMA UK Small Companies sector up 125%.
Given that kind of run, maybe it would be optimistic to suggest further stellar performance. Ian Rees, head of research, multi-asset funds at Premier, is one fund picker who has become more cautious on the sector this year.
He explains: “The main cause for our caution is that when you speak with managers they are struggling to find a lot of attractive alternatives stocks for their portfolios, and that’s quite different to managers in other regions, such as in Europe, where when things get expensive they are able to find lots of new ideas to move into.
“It seems within the UK that universe of opportunity is more constrained at the current time. That is predominantly why we have taken our small cap allocation down.”
Talent pool
Still, Rees acknowledges some of the talented individuals working in the sector, including Daniel Hanbury of River & Mercantile, Alex Wright of Fidelity and Paul Marriage of Schroders.
Mark Dampier, head of research at Hargreaves Lansdown, picks out Daniel Nickols of Old Mutual, Giles Hargreave’s Marlborough funds, and Harry Nimmo of Standard Life.
Keeping a small cap fund at a manageable size is a concern though, particular during times when performance and popularity is strong, while issues also arise when investors later sell out.
“The biggest problem is getting hit by a wall of money at the wrong time, which is what happened to a lot of groups towards the end of last year,” says Dampier.
“Determining the ideal size is difficult because it depends on how the fund manager is running the fund, but I’ve always said around £750m to £800m. Marriage’s fund went over £1bn, but is back under that and I think he is much happier with the size it is now.
“The trouble is that if you get really good performance, like he did for a couple of years, you then get a massive amount of money that’s then dumped at the end of the cycle, or after a good run like we’ve had for the sector over the past five years. If there has been a small correction, like we’ve had, then people instinctively want to take profits from the biggest gainers.”
The flows show
Rees is also concerned about the inflows and outflows: “There is nothing worse than buying a small-cap fund only to find further down the line that it has done well, attracted lots of assets and is no longer a small-cap fund.
“That is a reality of investing at the smaller-end of the market – the larger you get the more difficult it is to maintain that stance unless you look to capacity constrain the proposition.”