First with decent economic growth, many mainstream sectors have expanded at a good pace, and larger companies fully participated in this growth. On top of this, multinational companies often benefited disproportionally, as they participated in the extraordinary growth of the emerging economies too.
Finally, earnings growth has been enhanced further by gearing corporate growth with debt. Larger companies have enjoyed increasing access to debt as the corporate bond market has expanded rapidly over the last 25 years.
With such favourable trends, institutional interest in smaller companies has steadily declined during the boom. Many funds have narrowed their investment universe to those within the FTSE 350, given their easy market liquidity.
Investment at the bottom end of the market is troublesome and fiddly when compared with larger companies, which are sizable and liquid. Few institutional funds can really be bothered with them, so many have near-zero weightings. And given that mid-sized companies have outperformed over the last 15 years, most smaller companies funds are skewed the same way.
Performance of indices over 15yrs
Source: FE Analytics
However, market trends have changed. Europe is close to recession, and economic growth in Japan remains depressed. The UK and US have seen slight pick-ups, but these seem to run out of steam before they gather much momentum.
And while several emerging economies are still growing, this is often severely challenged by a rise in inflationary pressure, weak current accounts and currency setbacks. Plentiful growth is becoming rather thin on the ground.
The one great advantage of a smaller company is their inherent ability to grow, especially since this growth is not necessarily reliant upon expansion of the wider economy.
This growth potential has not been particularly distinctive during the credit boom, but as we enter a period of austerity, the differential is beginning to become more appreciated. Whereas capital allocations to UK Smaller Companies funds were negative for much of the last 20 years, this year we are seeing sizable and decisive inflows for the first time in years.
This is somewhat inconvenient for a lot of funds: trimming a few larger company holdings is the work of an afternoon, but finding a decent number of attractive smaller companies to buy takes a considerable amount of time.
There is little independent research on most smaller companies, and even when the best ones have been identified there is no certainty that capital can be invested. If anything, there are considerably more buyers than sellers, so stock which does become available is shared between those with live orders in the market.
The buying tension is made worse by the renewed inclination of existing smaller companies portfolios to reallocate their capital from the mid-sized businesses down the market cap range to the small and micro-cap stocks, which are now enjoying premium returns.
During the credit boom period, almost all smaller companies were relatively easy to buy, but most were often difficult to sell. Now we are entering a period where the most attractive stocks are relatively easy to sell, but most are difficult to buy.
As the sector outperforms, there will be increasing urgency for new capital to get involved. The problem is that small allocation changes in larger companies have a magnified effect in the small cap sector, given it is naturally defined by its limited scale.
We feel a bandwagon is on the move, which is restarting the previous trend of smaller companies outperformance. The previous trend lasted for decades; the question is, are we at the start of something similar again?
Gervais Williams runs the CF Miton Multi Cap Income fund, and was formerly at Gartmore.
His Miton fund is a top-decile performer in its IMA UK Equity Income sector since its launch in October 2011, with returns of 59.82 per cent. The sector and FTSE All Share delivered 34.79 and 30.68 per cent over this period, respectively.
Performance of fund vs sector and index since launch
Source: FE Analytics
In spite of the fact that it concentrates on the small cap market, it has been less volatile than both its sector and benchmark over the period.
CF Miton Multi Cap Income requires a minimum investment of £1,000 and has ongoing charges of 1.77 per cent.
