UK Smaller Companies funds are required to invest at least 80 per cent of their portfolio in firms that form the bottom 10 per cent of the market by capitalisation.
Key funds
Competition in the UK Smaller Companies sector is rife; nearly a third of the 57 funds are run by Trustnet Alpha Managers.
Standard Life UK Smaller Companies, Close Special Situations and Marlborough Special Situations are among the best-performing funds in the sector over a sustained period.
Harry Nimmo’s Standard Life UK Smaller Companies fund – which, with £1.2bn AUM is far and away the biggest fund in the sector – has returned in excess of 100 per cent over a five-year period, with a lower-than-average volatility.
Nimmo recently soft closed the fund because he was concerned that constant inflows were beginning to have a negative impact on performance.
Only Deryck Noble-Nesbitt’s Close Special Situations fund has returned more than Nimmo’s vehicle during this time, although it is substantially more volatile. Close Special Situations is also among the top-two performing funds over a three-year period, with returns of 85.22 per cent.
Giles Hargreave's £400m Marlborough Special Situations fund has the best record over a 10-year period, and is also a top-quartile performer over one, three and five years.
Performance of funds vs sector over 10-yrs
| Name |
1-yr returns (%) | 3-yr returns (%) | 5-yr returns (%) |
10-yr returns (%) |
| Close Special Situations |
25.9 |
85.22 |
111.67 |
N/A |
| Stan Life Inv UK Smaller Companies |
45.07 |
50.7 |
100.68 |
196.42 |
| Marlborough Special Situations |
46.2 |
47.97 |
89.92 |
289.45 |
| IMA UK Smaller Companies |
34.29 |
30.19 |
38.55 |
96.92 |
Source: Financial Express Analytics
Risks and considerations
Although some of the best-performing funds in the unit trust and OEIC universe sit in UK Smaller Companies, historically the sector is also one of the most volatile.
The performance of stocks with a small market cap will always be more sporadic than established FTSE 100 giants, and smaller companies are far more likely to default.
The stocks in a UK Smaller Companies portfolio are also less transparent than in a large or mid cap fund, which means the investor has less of an understanding of how the holdings operate.
UK Smaller Companies funds have performed well since the financial crisis. In a recent interview with Trustnet, Alpha Manager Derek Mitchell said small and mid cap companies tend to do much better than large caps in the aftermath of a recession.
However, like many other industry professionals, Mitchell thinks the small cap rally may be drawing to a close.
"As the market broadens out and more industries take part in the recovery, the dominance of these smaller companies will inevitably come to an end," he said.
Comparable sectors
The average UK Smaller Companies fund has outperformed the average UK All Companies fund over one-, three-, five- and 10-year periods. In the last decade, IMA UK Smaller Companies has returned 96 per cent, more than twice as much as IMA UK All Companies.
However, this outperformance has come at a price. UK Smaller Companies funds have been around 3 per cent more volatile than UK All Companies funds in this period, and lost substantially more during the financial crisis.
According to Financial Express data, IMA UK Smaller Companies was the worst-performing sector in 2008, losing investors more than 40 per cent.
The average IMA European Smaller Companies fund has returned 129.8 per cent in the last 10 years, outperforming IMA UK Smaller Companies by around 23 per cent.
The UK Smaller Companies sector also falls short over one- and five-year periods, though it fares better over three years. However, European Smaller Companies funds are even more volatile than their UK equivalents over every time period.
Performance of sectors over 10-yrs
Source: Financial Express Analytics
IMA North American Smaller Companies funds have fared better than those in the UK since the downturn, but with a higher risk score. Returns in the US have slowed in the last 12 months or so.
Over a 10-year period, UK Smaller Companies funds have returned more than twice as much as North American Smaller Companies, again with less volatility.
Our view
With the potential for massive returns and the calibre of managers on offer, IMA UK Smaller Companies is a sector that cannot be ignored. Investors that hold a small cap fund should anticipate high volatility and heavy losses in down markets, however.
For an investor who is willing to take on risk, or balance a defensive portfolio with a more adventurous vehicle, a UK Smaller Companies fund is a viable option.