Data from FE Analytics shows that the IMA UK Smaller Companies sector has returned more than the IMA Global Emerging Markets sector over one, three and five years.
Although the emerging markets sector leads over 10 years, our data shows that over 20 years the returns from smaller companies have been far higher.
Performance of sectors over 20-yrs
Source: FE Analytics
Emerging market funds outperformed in five out of the seven years from 2003 to 2009, pushing up the 10-year numbers.
However, since 2010 the UK Smaller Companies sector has performed better in every single calendar year.
Yet, despite making 46.58 per cent over the past three years – the figure for the emerging markets sector is just 11.35 per cent – smaller companies are still regularly near the bottom of IMA retail sales figures.
Performance of sectors over 10-yrs
| Sector | 1yr returns (%) |
3yr returns (%) | 5yr returns (%) | 10yr returns (%) |
|---|---|---|---|---|
| IMA Global Emerging Markets | 11.21 | 11.35 | 14.89 | 331.87 |
| IMA UK Smaller Companies | 24.16 | 46.58 | 41.16 | 222.93 |
Source: FE Analytics
Our data also shows that UK small cap funds have been significantly less volatile than their emerging market rivals in the short-, medium- and long-term as well.
According to FE Analytics, the average fund in IMA UK Smaller Companies has an annualised volatility of 16.51 per cent over 10 years, compared with 19.12 per cent from IMA Asia Pacific ex Japan, and 20.65 per cent from IMA Global Emerging Markets.
Richard Power, manager of the CF Octopus UK Micro Cap Growth fund, thinks investors obsessed with the emerging market growth story are missing on higher returns closer to home.
Power commented: "A lot of money has been sucked out of the IMA UK Smaller Companies sector in recent years. A lot of that is to do with investors looking for growth in emerging markets, when they have a great 'emerging market' on their doorstep."
Power’s £16.5m CF Octopus UK Micro Cap Growth fund invests across the FTSE Small Cap sectors and the AIM and PLUS markets.
The manager points out that the smaller end of the market offers many companies that are benefitting from superior GDP growth in developing countries, and that around 50 per cent of the earnings of companies on the AIM is derived from overseas.
This means that UK smaller companies are no longer as dependent on the health of the domestic economy as was the case in the past.
"Now we are getting smaller companies that are global leaders with disruptive technology. Revolutions are good for new companies," he said.
ASOS is an example of this, he explains, as the company has been able to get ahead of its rivals without the encumbrance of their physical infrastructure.
CF Octopus UK Micro Cap Growth has made 29.16 per cent over the past three years, according to data from FE Analytics, while the IMA Smaller Companies sector is up 46.58 per cent.
However, over that time it has beaten its composite benchmark – made up of the FTSE Small Cap and FTSE AIM indices, weighted at 50 per cent each.
Performance of fund vs sector and benchmark over 3-yrs
Source: FE Analytics
The fund holds 19.2 per cent in software and computer services, and Power says this is one area where small caps are currently strong.
"If you want to find growth in the UK, you need to look to the service and technology sectors – that’s where the double-digit earnings growth is," he said.
"The tech sector has changed. The sort of hyped-up valuations you get now are in social media and that’s happening in the US, it’s not happening here. These are good, solid companies people want to buy."
Investors often worry about the liquidity of investing at the lower end of the market cap scale, but Power says this is not an issue for anyone who gets stock-selection right.
"It’s part of understanding that end of the market. If your picks are successful it’s not a problem to sell, it’s only if the company does badly that you have problems," he added.
The fund requires a minimum initial investment of £1,000 and has a total expense ratio (TER) of 1.5 per cent.
It was launched with a performance fee, although this has been suspended and is currently under review.