Investing in smaller companies, while carrying a higher degree of risk than their larger counterparts, has been a rewarding way to stash your cash in the market over the longer term as well as producing some of the most highest-rated fund managers in the UK market today.
While mid-caps have been the best place to be over the last decade compared to large and small caps, the trend has reversed somewhat in the last five years with the most growth coming from the smallest firms.
The ongoing UK economic recovery as well as for other more secular reasons seems to have provided an ideal ground for many smaller companies to see rapid growth with a spate of initial public offerings occurring over the past 12 months. This has not meant an uninterrupted upward movement however, with several periods of weakness.
Performance of indices over 5yrs
Source: FE Analytics
Hargreaves Lansdown’s Mark Dampier (pictured) says due to the vast array of opportunities in the small-cap space, they can also provide better and more frequent opportunities when sentiment is weak.
“Mid and small cap areas are where you find the best active fund managers, in my view. The more doom and gloom I hear from the media, the more bullish I become,” he told FE Trustnet recently.
Two funds have some of the most widely known managers in the open-ended space running smaller companies portfolios, these are Fidelity’s Alex Wright and Schroders’ Andy Brough and Rosemary Banyard.
Wright has headed the £282m Fidelity UK Smaller Companies since 2008 while Brough has managed the £552m Schroder UK Smaller Companies since 1994. Jonathan Winton joined as Wright’s co-manager in 2013. Rosemary Banyard, on the other, joined Brough in 1998 as co-manager.
Over the longest comparable period of the two funds – since 2008 - Fidelity UK Smaller Companies has clearly had the most clout returning a mammoth 288.6 per cent to investors, the best performance in the IA UK Smaller Companies sector over this period.
The sector average returns have been 106.21 per cent while the FTSE All Share Small Cap index ex ITs gained just 83.5 per cent.
This meant Schroder UK Smaller Companies 122.48 per cent return came in above these two numbers but less than half of the return from Wright’s fund.
Performance of funds, sector and index since 2008
Source: FE Analytics
However, with markets more subdued in 2014 and to a lesser extent this year more recent performance has been similar with both funds returning just under 12 per cent over the past year.
Over three and five years both funds are top quartile although Fidelity UK Smaller Companies has, on a regular basis, outperformed the Schroder fund.
This performance led to strong inflows into Wright’s fund, which forced Fidelity to soft-close the fund at £250m in 2013. However, with sentiment towards small-caps now considerably weaker, the group re-opened the fund earlier this year.
According to the FE Research team, the Schroders fund has tended to outperform when markets have fallen demonstrated by its strong total return in the 2008 to 2009 and 2011 to 2012 periods.
“This is because its investment process is designed to pick quality companies that can provide stable returns in all conditions,” the team said.
“This characteristic has also given the fund a less risky profile than many of its competitors, but means it tends to lag behind its peers when markets are on the rise.”
The Schroder fund has clocked up the third lowest volatility in the sector over this period while Fidelity UK Smaller Companies has been substantially higher and greater than the sector average.
Nonetheless Wright has also done well in falling markets such as in 2011 when his fund lost less than the Schroders fund as well as last year when it turned a small positive return despite the index’s 3 per cent fall.
Performance of funds, sector and index in 2011
Source: FE Analytics
Wright’s value and contrarian approach to his portfolio means buying out-of-favour companies where he sees a catalyst for positive change and while this can sometime take several years, he has beaten the sector and index in each full calendar year since inception
“[Wright’s] focus on downside risk and subsequent protection of capital in severe sell-offs can be viewed as an extremely sensible approach in what has, historically, been a volatile asset class,” Square Mile, who has given the fund an ‘AA’ rating, said.
“This approach has proved very successful since the fund's launch and though there will be periods when this style of investing is out of favour it should reap rewards over the long term.”
Meera Hearnden, fund analyst at Parmenion, rates both funds highly, but says they offer very different exposure to UK small-caps.
She points out that investors should expect more of a growth style from Brough and Banyard while Wright is more value /contrarian orientated and therefore the choice of which is best comes down individual investor preference.
In fact, for those who want to take full advantage of the growth opportunities emanating from UK smaller companies, she says investors can feel comfortable combing the two funds within their portfolios.
“They are two funds we favour but are very different smaller companies funds. However, these two styles actually dovetail very nicely together in a portfolio..offering investors complementary styles of management,” she said.
"Fidelity UK Smaller Companies Fund can also hold non-UK names and I believe it can short positions making it different to the Schroders fund. It is also a truer small cap fund which plays to Fidelity’s large research capability, whereas some funds will run with its winners by holding a sizeable position in mid-caps."
"Schroder UK Smaller Companies Fund can hold up to 20 per cent in mid-caps and while they don’t invest in mid-caps at first purchase, they are happy to run with their winners. These stocks can also offer some comfort of liquidity which are easier to sell, when they find better small cap ideas."
While the two do not have much similarity in terms of their individual holdings with no overlap in their top 10, they both have their biggest overweight to industrials making up just under a third of each portfolio. Both funds hold five FE Crowns.
In terms of cost Fidelity UK Smaller Companies is more expensive with an ongoing charges figure [OCF] of 1.17 per cent. Schroder UK Smaller Companies has an OCF of 0.91 per cent.