Only two funds of the 51 in the IA UK Smaller Companies sector have proved to be more risky than the FTSE 100 over recent years, according to FE data, while over the long term the peer group has not been as turbulent as many might assume.
Investing in smaller companies offers investors the prospect of higher potential returns but they have to accept higher levels of volatility to get there. Our data shows that the FTSE Small Cap (ex ITs) index’s annualised volatility has been 18.71 per cent over the 20 years; the FTSE 100’s is just 13.90 per cent.
The FTSE Small Cap (ex ITs) index has returned 300.86 per cent over this 20-year period while the FTSE 100 is ahead 277.41 per cent. What’s more, the average IA UK Smaller Companies fund is up 629.65 per cent with annualised volatility of 16.57 per cent.
Performance of sector and indices over 20 years
Source: FE Analytics
Of course, they are often periods when small-caps lag their larger peers – as can be seen on the above graph. But significant gains can be made when investing after such periods of underperformance.
Following strong returns in 2012 and 2013, small-caps faced a more difficult 2014 after investors took profits after their stellar run and sentiment started to become more ‘risk-off’. Their recent underperformance has made smaller companies look attractive to some commentators.
Adrian Lowcock, head of investing at AXA Self Investor, said: “With stock markets hitting new or multi-year highs finding investment opportunities at cheap valuations has become more difficult. Whilst the UK market is not cheap, smaller companies are one of the more attractive areas where relative value exists.”
Some investors are more risk-adverse than others and the FE Risk Score tool seeks to offer a guide as to which funds are more or less risky than the FTSE 100. The tool defines risk as a measure of volatility relative to the FTSE 100 index, with a score below 100 meaning the fund has been less risky than blue-chip index over rolling three-year periods.
When it comes to the IA Smaller Companies sector, the funds with the highest risk scores are Standard Life Investments Ignis Smaller Companies, at 107, and SF Webb Capital Smaller Companies Growth, at 100. Both funds hold one FE Crown and have underperformed their average peer over one, three and five years – with a significant loss being seen in the case of the latter fund.
Performance of funds vs sector over 3yrs
Source: FE Analytics
When looking at the other end of spectrum, more positive stories can be found. The fund with the lowest FE Risk Score is Liontrust UK Smaller Companies at just 50. 
This fund, which is managed by the FE Alpha Manager duo of Anthony Cross and Julian Fosh, has outperformed its average peer over three and five years, being ranked as the eighth highest returning portfolio out of 49 over five years.
The fund is also well respected by the FE Research team, holding a place on the FE Select 100 thanks to careful positioning that has helped it to avoid the worst conditions of the market over recent years.
Our analysts said: “It is rare to find a fund that limits its losses to half those of its peers when markets fall, yet is still capable of leading the field when they rise again. However, much of this outperformance is due to being in the right place at the right time rather than because of any deft strategic manoeuvring by the managers.”
Although the FE Risk Scores only cover recent years, the fund has a strong long-term track record as well.
Since Cross joined the portfolio in January 1998 it has returned 675.28 per cent and beaten its average peer, benchmark and the FTSE 100 by a wide margin; this has come with annualised volatility that is just 2.72 percentage points higher than the FTSE 100’s and a maximum drawdown that is only 42 basis points worse.
Performance of fund vs sector and indices over manager tenure
Source: FE Analytics
Other highly rated funds with low FE Risk Scores include Artemis UK Smaller Companies at 54, Woodstreet Microcap Investment at 57, Marlborough Nano Cap Growth at 58 and Cavendish AIM at 59.
Of the 30 funds that have risk scores lower than 75, five appear on the FE Select 100.
FE Alpha Manager Andrew Brough and Rosemary Banyard’s Schroder UK Smaller Companies has a risk score of 61 and is a member of the Select 100 with its tendency to outperform when markets are falling being cited as a reason why it is one of the highest returning funds in the peer group.
Schroders has another Select 100 member in the sector – Paul Marriage and John Warren’s Schroder UK Dynamic Smaller Companies, with a 64 risk score.
Our analysts said: “The fact that the portfolio managed to protect investors’ capital in the falling market of 2011 makes it appealing, as this is not what is usually expected from a smaller companies fund.”
Marlborough’s Giles Hargreave has two funds with lower FE Scores and a place on the Select 100. The FE Alpha Manager’s Marlborough UK Micro Cap Growth fund has a risk score of 72 and Marlborough Special Situations scores 73.
The FE Research team says both funds are examples of the sector’s strongest when it comes to performance and the general quality of their investment teams. It also highlights the manager’s lowly concentrated portfolio as helping to reduce risk.
“It is unusual to have such small amounts of money invested in high-conviction positions, but as the share prices of smaller companies can fluctuate more violently, this diversity limits the impact of a single high-risk stock,” our analysts said.
Performance of funds vs sector and index over 5yrs
Source: FE Analytics
