Investors should not lose optimism even as warnings of the end of the six-year bull market in equities emerge, as there are plenty of opportunities in the small and mid-cap space, according to Hargreaves Lansdown’s Mark Dampier and Hawksmoor’s Jim Wood-Smith.
As a recent FE Trustnet study showed, the best portfolios since the fall of Lehman Brothers sparked the financial crisis are nearly all UK smaller companies-focused funds, which have hugely outperformed the broader index.
The likes of Fidelity UK Smaller Companies, MFM Slater Growth and Marlborough UK Micro Cap Growth have returned the most since the fateful day on 15 September 2008.
Performance of fund and index since Lehman crash
Source: FE Analytics
A further six of the next seven best funds in the Investment Association universe are either specialists in this area or are heavily overweight it.
Wood-Smith, who is head of research at Hawksmoor, and Dampier, head of research at Hargreaves Lansdown, both think that despite the maturity of equity markets the case remains for investing in small and mid-caps funds over larger caps.
Wood-Smith (pictured) said: “Global equity has passed an inflexion point. The bull market is over. For the moment, let us not argue about the causes … global equity, led by Wall Street, is giving clear and classic signals that the post-March 2009 bull market has run its course.”
“This does not mean every stock is going down and a nice number of charts currently remain very positive. Mid and small caps are not nearly as worrying as large companies,” he added.
Dampier (pictured) says, on the whole, small and mid-cap stocks have been the main area to be invested in during the market recovery and this still very much the case despite the rally since 2009. He adds that while there may well be substantial falls along the way, investors should hold firm.
“You just have to ‘take the slings and arrows’ when things go wrong. In 2008, for example, they were absolutely terrible but that is what happens in those sorts of crises,” he said.
“However I don't expect them to continue at that [2009 bull market] pace. Because the mid-cap index is a broader, more refreshed index, from an active point of view managers are more likely to be able to add value than in the FTSE 100.”
“If I was going buy the FTSE 100, I'd probably just buy a passive fund anyway and you could argue that might actually be good idea now but I just think mid and small-caps will always be a good area to be invested in over the longer term.”
As far as our data goes back – the end of 1985 – mid-caps have been overwhelmingly the best place to be invested.
Performance of indices since 31 Dec 1985
Source: FE Analytics
This is also true over 10 and 20 years but it has been the small cap end of the market that has dominated over five and three years.
Performance of indices over 5yrs
Source: FE Analytics
As Chelsea Financial Services managing director Darius McDermott notes: “Smaller companies all over the globe really have been the place to be over the past three years.”
However, both the FTSE 250 and FTSE Small Cap indices have generally been more volatile, but Dampier says for long-term investors this should not be a worry.
“My question to all the bears is, it is very well [to be bearish] but if you miss the first 350 per cent [of a rally], how good are you?” he asked.
“Every now and then they will have a year like 2008 where ... it really was poor. But looking from that point onwards then they have still just done brilliantly. How many people just sold them near the bottom and never bought back? Some of the funds are up 300 per cent since then.”
“You have to be patient and most people are just not patient. To be master of inactivity is what you want and to stop making decisions all the time. Small and mid-caps have actually performed pretty well against the current environment. It is the FTSE 100 that has taken the full clobbering”
Wood-Smith thinks such falls in the broader market this year are evidential of a more bearish tone from global investors, which suggests an end to the post 2009 bull run. However he says this does not mean every stock market is going to go down and fixed income yields have not shown any major sign of panic.
“That is extremely unlikely. But, according to the charts, index levels are going lower; quite possibly a lot lower. This is true for both developed and emerging markets,” he said. “Bond markets … are not worrying. US yields look likely to edge slightly higher, while UK gilt and JGB yields are actually trending lower.”
Paul Abberley, chief executive at Charles Stanley, is another that believes the end of the strong market recovery that quantitative easing and zero interest rates has prompted in stock markets, but – again – does not think this is reason enough for investors to move into cash.
“The UK equity market has fallen by 10 per cent across the summer. But is now the time to buy? Our view would be a qualified yes, but with rather modest return expectations and possibly much volatility along the way,” he said
“A combination of zero interest rates and quantitative easing has provided a tail wind for equity markets, as liquidity has been flushed through the financial markets. But stocks are pretty fully valued and that phenomenon is also drawing to a close.”
“Equity markets have benefited from companies taking the lion’s share of the gains from the economic recovery and have been further supported by buoyant liquidity. While a reversal of these trends might not be in prospect, their fading impact does require a more sober estimation of future returns.”