The recent outperformance of small and medium-sized companies means that UK funds with high weightings to this part of the market have produced some of the highest returns but at the same time they have also given their investors a less risky ride, according to FE Analytics.
Over the three years to the end of January 2016, the FTSE 100 has made a 7.99 per cent total return. But as the graph below shows, this was the result of a strong 2013, a broadly flat 2014 (the index was up just 0.74 per cent) and a 1.32 per cent fall in 2015.
At the same time, stocks further down the market cap spectrum have surged ahead of the blue-chips with the FTSE 250 gaining 36.88 per cent and the FTSE Small Cap rising 29.69 per cent.
Performance of indices over 3yrs to end of Jan 2016
Source: FE Analytics
Large-caps are often seen as being a lower-risk part of the market but a closer look at the three indices shows how this has not been the case over recent years, as fears over the health of global economic growth and the impact of higher interest rates caused investor sentiment to global-facing companies to stall.
The maximum drawdown – or the most an investor would have lost if they bought and sold at the worst possible times – of the FTSE 100 has been 12.14 per cent over the three years in question; for the FTSE 250 it has been 7.80 per cent while for the FTSE Small Cap it has been 7.23 per cent.
Likewise, annualised volatility for the FTSE 100 has been 11.07 per cent but it falls to 10.86 per cent for mid-caps and 8.24 per cent for the small-cap index.
The effect of these conditions can be seen when looking at the FE Risk Scores for the IA UK All Companies sector. FE Risk Scores measure the volatility of a fund relative to the FTSE 100 which is given a score of 100; funds with a score below this are deemed to have been less risky than the index while those above 100 have given investors a more volatile ride.
The average FE Risk Score for the IA UK All Companies sector stands at 87, with 253 of the 266 scored funds sitting below the 100 mark.
Filtering the peer for members that have achieved first decile total returns over the past three years and FE Risk Score leaves us with just four names, shown below.
Source: FE Analytics
All four of these funds have significant weightings to small and/or mid-caps, which means they have achieved some of the highest returns of their peer group but without exposing their investors to the heightened volatility being seen in the FTSE 100.
MFM Bowland is managed by small-cap specialist Hargreave Hale and counts small and micro-caps like Avon Rubber, Renew Holdings and Advanced Medical Solutions as top 10 holdings (according to its most recent semi-annual report). Despite its predominately small-cap focus, it also has major positions in FTSE 250 names like Booker Group and RPC Group.
Peter Webb’s Elite Webb Capital Smaller Companies Income & Growth has close to two-thirds of its portfolio in micro-caps and 31 per cent in small-caps. Its top holding is Lighthouse Group, followed by Safestay, Pendragon and Secure Trust Bank.
Keith Ashworth-Lord’s Premier ConBrio Sanford Deland UK Buffettology fund, which has an exclusive UK licence to use the Warren Buffett names and investment philosophy, has Bioventix, Scapa Group, Dart Group and NCC as its top holdings.
FE Alpha Manager Mark Slater’s MFM Slater Growth fund has small companies like Hutchison China Meditech and Redcentric in its top 10, but is also holds mid-caps such as Bellway and Regus. However, his fourth biggest holding is US large-cap Walt Disney.
While the above funds and others with a bias to small and mid-caps have seen risk metrics decline over recent years, it’s worth keeping in mind that this is down to the underperformance and high volatility seen in the FTSE 100 rather than being a signal that investing further down the market-spectrum has become significantly less risky.
Over the long term, small and mid-caps have given investors a rockier ride than large-caps and presented them with larger losses in times of market stress, albeit with the potential for higher returns. The below table illustrates that, showing the performance annualised volatility and maximum drawdown of the three indices over the past 20 years.
Source: FE Analytics
These figures support the view – which may have been forgotten by some because of recent market conditions – that smaller companies investing has been fraught with significantly more downside risk than larger-caps. The FTSE Small Cap’s 57.02 per cent maximum drawdown, for example, is almost 13 percentage points higher than the biggest loss made by the FTSE 100.
