Over 15 years the IMA UK Smaller Companies sector has returned 230.84 per cent, compared with 136.1 per cent from IMA UK Equity Income and 96.89 per cent from IMA UK All Companies.
Performance of sectors over 15-yrs
Source: FE Analytics
It is true the small cap funds have a higher volatility – with an annualised score of 18.51 per cent, compared with 15.49 per cent for the IMA UK All Companies sector and 14.19 per cent for IMA UK Equity Income – and did worse in the falling markets of 2002 and 2008.
The max drawdown – the amount investors would have lost if they had bought and sold at the worst possible moment – is 52.67 per cent for the IMA UK Smaller Companies sector but just 45.79 per cent for IMA UK All Companies and 44.75 per cent for IMA UK Equity Income.
However, smaller companies' margin of outperformance during bull markets means that they come out on top over the long-term.
Year-on-year performance of sectors
| Name | 2012 returns (%) | 2011 returns (%) | 2010 returns (%) | 2009 returns (%) | 2008 returns (%) |
| IMA UK All Companies | 5.69 | -7.04 | 17.53 | 30.4 | -31.96 |
| IMA UK Equity Income | 6.14 | -2.9 | 14.58 | 22.88 | -28.54 |
| IMA UK Smaller Companies | 9.72 | -9.04 | 31.56 | 50.18 | -40.54 |
Source: FE Analytics
This is reflected in the three sectors' respective Sharpe ratios*, which show that IMA UK Smaller Companies’ volatility brings with it proportionately higher returns.
The figure for IMA Smaller Companies is 0.34, more than twice as high as that of the UK Equity Income sector.
The figure for the IMA UK All Companies sector is even lower, although distorted by the trackers it houses.
Comparison of sectors
| Name | Max drawdown | Max gain | Max loss | Sharpe ratio |
| IMA UK Smaller Companies | -52.67 | 26.93 | -31.11 | 0.34 |
| IMA UK All Companies | -45.79 | 19.22 | -29.85 | 0.07 |
| IMA UK Equity Income | -44.75 | 17.96 | -26.37 | 0.16 |
Source: FE Analytics
Furthermore, when the sectors' returns are measured from trough to trough, IMA UK Smaller Companies comes out on top, meaning that after a cycle of bull and bear runs it leaves investors better off.
From October 1998 to April 2003, the sector made 20 per cent, having been up 143.89 per cent at its peak.
Over the same time period, IMA UK All Companies lost 12 per cent, having peaked 55 per cent up, while the IMA UK Equity Income sector was flat, having risen by 40 per cent at its highest point.
An examination of the period between the market troughs in 2002 and 2008 shows a similar pattern, with the IMA UK Smaller Companies sector up by nearly 50 per cent in the period.
This research backs up a recent study of the highest-rated FE Alpha Managers, which was dominated by representatives from the IMA UK Smaller Companies sector.
Three of the top-rated managers over 10 years run small cap portfolios, with only emerging markets managers challenging their performance.
The real threat to investors in the smaller companies sector is buying at the market's peak.
This is an issue with all investments, of course, and last weekend FE Trustnet published an article outlining how investors can avoid making poor timing decisions.
*The Sharpe ratio determines which indices have the best risk-adjusted performance over the set periods. It measures a fund's return relative to a notional risk-free investment – in this case, cash. The difference in returns is then divided by the investment's volatility.