UK smaller companies are likely to perform more resiliently than their larger peers throughout the recession, says Brian Dennehy, managing director at FundExpert.co.uk.

The IFA says that small caps are regarded as risky by the majority of investors, in the face of overwhelming evidence that suggests otherwise.

"Dynamic smaller companies are vital to the health of the UK economy and the best of them are doing rather well," he commented.

"Unlike larger companies, smaller companies are not overwhelmed by broader macro trends. Many smaller companies can maintain good performance regardless of what is happening in the wider economy because they are positioned in niche growth markets."

Despite the turmoil of the past six months, data from FE Analytics shows that the average UK Smaller Companies fund has outperformed the average UK All Companies fund during this time by 1.75 percentage points. Smaller companies have also outperformed over the last one, three, five and 10 years.

Performance of sectors over 1-yr



Source: FE Analytics

High levels of trading in FTSE 100 companies have seen share prices swing dramatically as investors take flight at the first sign of trouble and pile back in when they are more confident.

Dennehy thinks that this risk-on, risk-off trade has hurt the performance of blue chip share prices.

"Conventional thinking suggests the shares of large, well-financed dividend-paying companies are better equipped to perform well in the current environment," he said.

"However, the evidence is that they are more volatile and at the mercy of the latest news on the likes of QE and LTRO."

"Smaller companies, on the other hand, have been outstanding. An investor in the average fund invested into UK smaller companies over the last 10 years would have been rewarded with returns of 151.36 per cent; this contrasts with a relatively miserly 58.85 per cent for UK All Companies funds invested primarily in larger companies."

FE Trustnet research has questioned small caps' reputation for high volatility. Our data shows that the average UK Smaller Companies fund has an annualised score of 13.42 per cent over the last 10 years, compared with 16.54 per cent from the average UK All Companies fund. The sector has also been less volatile over one, three and five years.

The top-performing funds in the UK Smaller Companies sector are Liontrust UK Smaller Companies, Investec UK Smaller Companies, Cazenove UK Smaller Companies and Marlborough Special Situations. Each has an FE Alpha Manager at the helm.

The Liontrust UK Smaller Companies portfolio has also consistently been one of the least volatile in the sector.

Dennehy says that small cap fund managers are looking to companies that have international exposure in growth markets, particularly in emerging regions, and highlighted three firms with these characteristics:


Oxford Instruments

"Oxford Instruments is a manufacturing and research company that designs and produces tools and systems for industry and research," he said.

"The company started as a spin-out from Oxford University and now holds world-leading positions in high growth markets – a true British success story."

"As opportunities present themselves in emerging markets that continue to invest heavily in developing industrial knowledge and productivity, the business is well positioned to grow into the future."

Threadneedle UK Smaller Companies, Jupiter UK Smaller Companies and Baillie Gifford UK British Smaller Companies all have Oxford Instruments in their top-10.


IP Group

Dennehy continued: "IP Group is a leading UK intellectual property commercialisation company, with a portfolio of more than 60 companies in the energy and renewable, medical equipment and supplies, pharmaceutical and biotechnology, IT and communications, and chemical and materials sectors."

"One of IP’s most promising investments is Oxford Nanopore, which specialises in the direct measurement of proteins including DNA."

"Later this year it is due to launch a desktop gene sequencer which could lead to a complete revolution in the way medicine and scientific research is carried out. Unsurprisingly the company’s shares have increased fivefold since a low in 2010."

Threadneedle UK Smaller Companies and Baillie Gifford British Smaller Companies list IP in their top-10.


Brammer

"Brammer is Europe’s leading distributor of industrial engineering products, which it provides to industries such as aerospace, automotive, construction, pharmaceuticals and transport."

"A company with excellent prospects, new clients in 2011 included Indian giants Tata Steel and BAE Systems. Its biggest sales growth was in eastern Europe," Dennehy finished.

Fidelity UK Smaller Companies, JPM UK Smaller Companies and Lazard UK Smaller Companies are all invested in the company.