This is according to Neil Shillito, director at SG Wealth Management. He is a big fan of the sector and says investors must appreciate that a sluggish economy does not necessarily mean that UK companies will struggle as well. "There is the perception that during times of economic slowdown and recession, the UK corporate market will be heavily affected; it is a myth," he said.
"When you are in a perceived environment of economic tension and low growth, smaller companies are often able to adapt."
"Some obviously don’t and go bust, but not only can good companies adapt, they can also take advantage of the situation."
"Smaller companies are a good area for early-stage growth and are also the best barometer of economic growth, because if they are thriving then larger companies will follow."
"The UK small cap market is very, very under-researched and even in the big fund houses, there are only a handful of analysts that concentrate on it."
"Instead of overly focusing on emerging markets for growth, investors should know there are plenty of home-grown opportunities," he added.
Rob Morgan, analyst at Charles Stanley Direct, says there is a huge array of opportunities in the UK small cap space and that he is baffled as to why more investors do not take advantage of the sector, especially as it has delivered such high returns over the years.
"It is an area of the market that is overlooked by most, but in terms of performance, UK small caps have matched the returns of emerging markets over any number of time periods," Morgan said.
Our data shows that although the FTSE Small Cap has underperformed against the MSCI Emerging Market index over 10 years, it has beaten it over one-, three- and five-year periods.
Performance of indices
| Name | 1yr returns (%) |
3yr returns (%) | 5yr returns (%) | 10yr returns (%) |
|---|---|---|---|---|
| FTSE Small Cap Index | 25.78 | 40.27 | 40.24 | 169.29 |
| MSCI EM (Emerging Markets) | 8.41 | 7.83 | 24.67 | 362.13 |
Source: FE Analytics
Although the average emerging markets fund has beaten the average UK smaller companies fund over the last decade, it is a different story when looking at individual portfolio performance over the long-, medium- and short-term.
Comparing the returns of the best-performing funds from the IMA UK Smaller Companies, IMA Global Emerging Markets and IMA Asia Pacific ex Japan sectors over 10 years, it is a UK small cap fund that comes out on top.
FE Alpha Manager Daniel Nickols’ five crown-rated Old Mutual UK Smaller Companies fund has delivered the highest returns of any fund from all three sectors, at 594.17 per cent.
This puts it ahead of both the Aberdeen and First State Emerging Markets funds.
It is a similar story over five and three years.
FE Alpha Manager Alex Wright’s Fidelity UK Smaller Companies fund is the best performer in the UK Smaller Companies sector over five years, beating the best Asia Pacific ex Japan fund – Aberdeen Global Asian Smaller Companies – by more than 25 percentage points.
Performance of funds over 5yrs
Source: FE Analytics
Over three years, Paul Marriage’s Cazenove UK Smaller Companies fund comes out on top, with returns of 101.34 per cent.
Out of the three sectors, the 10 best performers are UK Smaller Companies funds; Newton Asian Income, in 11th place, is the highest-ranking emerging markets fund.
The average fund in the IMA UK Smaller Companies sector has also been considerably less volatile than its emerging markets counterparts overt the short-, medium- and long-term.
Morgan says that the large number of investable companies in the UK small cap indices and their high growth prospects mean they are more likely to outperform blue chips over the long-term.
"Smaller companies have always had a higher growth rate; it is the old adage that elephants don’t gallop, because it is much easier to turn a £1m company into a £2m company than one which is £1bn into £2bn."
"There are higher growth rates, but of course the downside risks are higher. They are much more economically sensitive and are less liquid, so if investors were looking to offload stocks that would have a huge effect on a smaller company’s share price."
"Despite that, the long prospects are really, really good and it is the sort of thing investors should have exposure to in their portfolio."
"It is an easier area of the market for fund managers to outperform as well," he said.
"If they put in the propriety research, they can generally outperform. No-one can tell you anything new about the likes of Shell and HSBC, but by analysing smaller companies, managers can get a genuine edge over their peers."
"There are so many differentials in the UK small cap market that it is an area where active management can add huge value," he added.