However, many investors will be somewhat wary of small caps: firstly because small caps tend to be less liquid than larger companies and also because while they can rise quickly, companies further down the market cap spectrum are also at a higher risk of going bust.
In this low-interest environment, however, investors looking to increase the value of their capital over the long-term cannot afford to ignore equities and one of the best ways for them to give their portfolio an added kick is through small and mid cap stocks.
For the investor who wants the best of both worlds – the stability of larger firms with the all-out growth of smaller companies – the Mercantile Investment Trust is a worthwhile option.
Martin Hudson, manager of the £1.7bn trust, says it is the only trust in the IT UK Growth sector that offers investors access to both small and mid cap companies in one vehicle.
"There are several that focus on smaller companies and two that do mid caps only, but we have the luxury of investing in both," he said.
The manager said the portfolio is currently split with 90 per cent in mid cap stocks and 10 per cent in smaller companies.
"We can have bigger companies – really successful growing companies – but also really little acorns that we’re buying for the future," he said.
"It’s very true that over the longer term, the trust offers more stability and more growth. We have the solidity and more stable growth but also the prospects of super growth from smaller companies. We’re able to nurture them and guide them through the investment trust structure where we are not forced sellers."
The strategy has paid off over the long-term, but has held up over the shorter-term as well.
The Mercantile Investment Trust has returned 226.3 per cent over the last decade, while its peers in the IT Growth sector made just 144.53 per cent.
The trust is benchmarked against the FTSE All Share ex FTSE 100 ex Investment Companies index, which is not covered by FE Analytics data. The FTSE All Share made 136.72 per cent over the period.
Performance of trust vs sector and index over 10 years
Source: FE Analytics
The Mercantile Investment Trust aims to deliver capital growth from a portfolio of medium-sized and smaller UK companies, as well as maintaining a long-term dividend at least in line with inflation – something it is currently holding up to.
The trust has also outperformed both measures over one, three and five years. It is yielding 2.78 per cent.
In spite of its outperformance, the trust is trading on a discount of 12.6 per cent, which means investors can access it for less than the value of its underlying assets.
It also has low charges of just 0.49 per cent, something that Guy Anderson, co-manager on the trust, says is one of the key advantages of its closed-ended structure.
Anderson adds that he, Hudson and co-manager Anthony Lynch are further able to take advantage of rising markets by employing an element of gearing – or leverage – in the portfolio. Anderson adds that the team actively manages this tool in response to momentum in markets.
"We are currently 10 per cent geared and we have a limit of 20 per cent gearing, but that number can and does move around dependent on conversations we have with the board," he said.
Overall, the team likes investing in small and mid cap companies because they are less researched than large caps and offer the chance to find 'diamonds in the rough' that will become the next big thing.
"Small and mid caps are not as well known and not as well researched, but they are where new themes come from in the UK," Hudson said. "And you do still get value opportunities presenting themselves."
The manager stresses that there are better growth and value opportunities further down the market cap spectrum and, in his view, this makes them the most interesting part of the market.
The team is particularly bullish on the UK housing market at the moment and names such as Persimmon, Bovis Homes Group and Barratt Developments feature in the top-10 holdings.
Hudson says housing companies have done well in getting rid of what stock they could after the crisis and repairing their balance sheets.
"Their earnings will continue to do better than the City thinks," he said.
When asked if the team is able to run its winners once they have exited its normal investment sphere, Hudson said the managers always sell, but do not rush into it.
"We don’t have a hard and fast rule that we sell on day-one at promotion," he said. "There’s very often some momentum beyond that move, so we can hold the stock for as long as 18 months after promotion."
