Whenever the economic outlook turns nasty, commentators are quick to talk up the resilience of the UK's biggest defensive stocks. They say Vodafone, Tesco and the utilities generate cash month in, month out, so should be able to weather a downturn better than rivals.
At the opposite end of the scale lie the UK's small businesses. The consensus states they are often first to suffer in a downturn as orders dry up and cashflow problems mount. The bank credit squeeze will not have helped their cause in the last year.
A recent survey by the Federation of Small Businesses (FSB) suggests smaller company bosses are indeed feeling glum. Confidence worsened over the second quarter of 2010. Two-thirds of businesses reported they were operating under capacity. Revenues were not expected to have improved in the three months to the end of September. That may signal a tougher trading environment for the IMA UK Smaller Companies sector.
The sector averaged returns of 14.44 per cent over the five years to the end of last month. The best performers were the Standard Life UK Smaller Companies fund, up 79.57 per cent, and Old Mutual UK Select Smaller Companies and Investec UK Smaller Companies funds, up 54 per cent.
Best performing IMA UK Smaller Companies funds, 5-yrs
Source: Financial Express Analytics
UK Smaller Companies suffered in the crisis but bounced back strongly. Three year average losses were -15.57 per cent, compared with a smaller average drop of -11.14 per cent for UK All Company rivals. But sector averages also hide a wide range in performance. Close Special Situations, an eclectic portfolio, streaked ahead of rivals with returns of 28.56 per cent. It remained a chart topper until very recently.
The sector subsequently rebounded as the recovery got underway. The Close fund is up 170 per cent since March last year, having grown four times faster than large cap trackers such as L&G UK Index and Halifax UK FTSE All Share Index Tracker.
Harry Nimmo, Trustnet Alpha Manager (pictured right) of the Standard Life UK Smaller Companies fund, has driven his fund up 73 per cent since the market bottomed out. He insists: "The fund and the approach I take are less volatile and less risky than a FTSE 100 tracker."
His reasoning is simple. The top 20 FTSE 100 stocks make up 70 per cent of the index. They are concentrated in a handful of sectors, notably oil and gas, mining and banking. A single event can substantially knock the index’s performance, as BP investors found to their cost this summer.
In contrast, small cap indices are more evenly balanced. Their largest constituents have a smaller weighting. Potential for damage to the Standard Life portfolio is also limited by a 5 per cent maximum position in any stock. “The amount of damage they can do is always limited," Nimmo said.
He added that small cap managers are often more closely tied to the fortunes of their business. Half of his top 30 stocks are still run by the people who started their firms themselves. The majority have never resorted to private equity funding. Nimmo said: "They have big stakes and that is an important discipline."
Fund managers are not the only investors to notice tight discipline and control. Deryck Noble-Nesbitt, manager of the Close Special Situations fund, says smaller companies have become attractive acquisition targets. He said: "A reasonable number of companies are being taken over. Premiums range from 80 per cent to over 200 per cent based on their prices at the beginning of the year."
Engineering consultant Scott Wilson, a stock held by Noble-Nesbitt, was bought for a 214 per cent premium, despite its large pension deficit. Even economically sensitive stocks are being targeted. A bid by Kuoni would have seen specialist travel company ET-China sold for a premium of over 300 per cent earlier this year. The acquisition has been delayed until December.