There are strong arguments for including smaller companies in a diversified portfolio.
The benefits come to the fore when considering long term returns and in the process can help support entrepreneurialism in the UK.
Given research is not as readily available compared to larger entities, fund managers have a major role to play in doing this themselves, creating portfolios of smaller companies, and actively managing those portfolios with the aim of adding real value for investors.
John Baron, financial commentator and a former fund manager, points to how smaller companies tend to outperform their larger brethren.
He predicts the small cap sector in general should continue to do so in 2022.
He told Investors Chronicle: “Although there have been periods of underperformance, an overweight position in smaller companies has proved to be one of the more reliable investment strategies in generating higher returns relative to the wider market.
“The fundamental reason is that elephants don’t gallop. Smaller companies tend to be more ‘nimble’ in seeing opportunities and responding to market changes. There is less baggage and bureaucracy to handle. They tend to be more entrepreneurial. Indeed, by comparison, the lack of entrepreneurship in our larger companies, and adherence to a financial system too focused on the short term, has plagued their performance.
“If anything, the advance of technology is quickening the pace of smaller companies. By helping to reduce costs and find new markets both at home and abroad, it is better enabling them to embrace the disruptive practices needed to better compete regardless of size.”
Downing Fund Managers agrees that “small is beautiful”.
It sees the UK small/micro-cap element of the market as being “very attractive”.
It goes on: “In the first half of 2021, UK smaller companies represented the top performing Investment Association (IA) sector, generating a total return of circa 20 per cent.
“Despite this impressive performance, it is an area of the market that is often overlooked. This is fundamentally due to inefficiencies and a lack of analyst cover both on the buy and sell side.
“Compared to larger peers, and those in other geographies, UK small caps look cheap. It is therefore no wonder that the level of corporate activity and inward buyers to the UK small cap market is so buoyant.
“They often fulfil very specific needs and operate in niche markets. Many small businesses have survived Covid-19 and emerged stronger and with more operationally efficient business models.”
How best then to go about taking advantage?
Downing Fund Managers notes: “There are a number of ways, but we believe that investment trusts are ideally suited.
“Investment trusts can offer reliable streams of income, the opportunity for strong long-term growth, and access to less liquid assets in a stable, closed-ended structure. For investors looking to take advantage of the recovery in markets and positive outlook for the domestic economy, UK small and micro-cap investment trusts make a compelling opportunity for attractive returns in the short, medium, and longer term.”
Merryn Somerset Webb, editor of UK personal finance magazine MoneyWeek, added: “We are living in strange times. But the basics of investing remain the same: buy fairly-priced stocks that can provide an income. And there are few better places to look than UK small-cap stocks.
“Small-cap stocks are still benefiting nicely from the recovery in the UK (clouded slightly by supply problems) and they also look pretty inexpensive relative to the rest of the market which is in itself cheap overall both in terms of historical averages and international comparisons.”
Your financial adviser can provide further guidance if this is a market segment which interests you.