With blue-chip stocks thriving at the moment, it may be a struggle for some to step away from large cap companies as many commentators expect the FTSE 100 to outperform for some time to come. On the other hand, small-caps often present under-recognised investment opportunities that can provide huge growth potential to any portfolio.
So should investors take another look at small-cap funds, given their recent run of underperformance?
Charles Hepworth (pictured), an investment director at GAM and a member of GAM’s Managed Portfolios Investment team, said: “In terms of UK small caps, arguably a lot of the underperformance drag by small caps to large caps has already been made up post the financial crisis in 2011-2013.”
“Actually, since March 2009 the small cap index has shown nearly double the large cap FTSE 100’s performance.”
While Hepworth does not allocate to small caps at the asset allocation level, he would not recommend a plunge into the asset class given how far they have come in recent years.
However, there are other investors who believe there is still more room for growth in this part of the market in the current economic climate.
Lee Robertson, chartered wealth manager and founding director of Investment Quorum, said: “We are starting to get very interested in small-caps again. It’s that constant hunt for value. Stocks frequently gets over-priced, so we think there are some interesting opportunities beginning to come out again in small-caps.”
“We don’t have a massive amount in small caps in our portfolio, but we are beginning that whole thought process of ‘should we start to increase it?’ and we think that we probably will begin to buy back in.”
Despite their huge falls during the financial crisis of 2008, small caps are beginning to catch up with the FTSE 100.
Performance of indices since March 2007
Source: FE Analytics
So why are so many investors selling down their exposure?
Miton’s Nick Greenwood said: “Small-caps have held up fairly well over recent months, but the sentiment has been against them. You can see that in the movement of some investment trusts that specialise in the sector.”
“Because sentiment has deteriorated, people have been expecting poor performance yet that hasn’t actually happened.”
Greenwood cut back on his small-cap exposure some months ago and now holds just 3 per cent in the Rights and Issues Investment Trust, which has £123m worth of assets.
He said: “What has probably happened is that a number of asset allocators, myself included, are running a global portfolio and they’re looking at the upcoming election.”
“There’s lots of concern over whether we’re going to pull out of Europe and that might mean the sterling will become weak. Therefore investors probably want to be trimming their UK exposure, and the small cap sub-sector is an area where you would make a cut.”
In contrast, Georgina Brittain, portfolio manager on the JP Morgan Smaller Companies Investment Trust, says there is no time like the present to increase small-cap exposure.
She said: “The simple reason is valuation, where are we now? Compared to all of the rest of the market, smaller companies are undervalued at the moment. The reason we believe small-cap is due to have its time in the sun again is because, as everyone knows, large caps are very global and they’ve got huge amounts of commodities.”
“But all those big oil companies etc aren’t really the place you want to be at the moment. With small-cap you are looking very much at more domestic exposure and very clearly, aside from the election, the UK is in a better place than people expected it to be right now.”
Cavendish Asset Management’s Paul Mumford shares a similar sentiment. On Wednesday, Mumford told Trustnet of his inclination towards the small cap oil sector. However, he also favours a range of other small cap sectors, including property and pharmaceuticals.
He said: “As far as timing is concerned, I think it’s quite a good time to look to smaller companies at the moment because the background is good. You’ve got low interest rates and the economy looks relatively healthy.”
“That’s not to say that the election isn’t something that’s going to create a lot of uncertainty though. I think a lot of investors would be tempted to build up their cash reserves until May or alternatively see what the result of the election is likely to be.”
“The problem with the smaller companies is the fact that you won’t always get successes. If you get a failure, then it’s easier for the smaller company to be bought to its knees. But having said, that you’ve still got companies like Northern Rock going bust and it can happen to any size company you’re looking at.”
Mumford, whose favourite small-caps include Allianz Pharma and Ergomed, said that it may be a little early to get into the market at the moment, but that the answer is to be selective.
“If the company has good fundamentals, then it’s probably worth buying,” he added.
Is it as simple as choosing an investment that looks good on paper, regardless of size? iBoss’ Chris Metcalfe seems to think that it is, to an extent.
“It’s about getting a balance,” he said. “A bad small-cap will be a bad small-cap, even in a good time generally for small-caps. Large caps have had a good time but if it’s Tesco or an oil company then it’s been rubbish.”
Metcalfe, who only owns one fund without small-cap exposure, believes this area is where the growth is going to be. John Wood’s JOHCM UK Opportunities is the only fund he holds without small caps; across his portfolios, he has almost 30 per cent in small caps.
He said: “We like the managers who will go there with small-caps. What we do try and shy away from generally is managers who are specifically large-cap and they are large-cap hell or high water.”
“We have seen a rotation from some of our fund managers into these mid and small caps because that’s where they see the growth to be.”
In a coming article, FE Trustnet will look at the funds and trusts the experts tip for small-cap exposure.