2021 could be a year of powerful performance from small-cap funds – if the recovery from previous down years for the market is anything to go by.
Data from FE Analytics shows small-cap funds and sectors have dominated the top of performance tables every calendar year preceded by one in which the MSCI World index ended in negative territory.
Although the index looks set to end 2020 in positive territory – it is up 13.31 per cent in the year to date – many markets, particularly those without a heavy weighting to tech, such as the UK, are still well down on their starting values.
If, as expected, 2021 is characterised by a period of recovery, history suggests this would play into the hands of small-cap funds.
The MSCI World last suffered a negative year in 2018, when a period of hasty monetary tightening by the Federal Reserve was blamed for the index’s 3.04 per cent loss.
A reversal in this policy the next year helped the index swing into the black with a 22.74 per cent return. While IA Technology & Telecommunications was the best-performing sector over this 12-month period, with gains of 30.98 per cent, IA North American Smaller Companies and IA UK Smaller Companies took second and third place with gains of 25.8 and 25.34 per cent, respectively.
Best-performing sectors in 2019 and 2012
Source: FE Analytics
In terms of individual funds, three of the top-10 in that year – ASI UK Smaller Companies, Franklin UK Mid Cap and MI Chelverton UK Equity Growth had a small/mid-cap bias, although the top-performer was Allianz China A-Shares, with gains of 53.64 per cent.
It was a similar story in 2012. The MSCI World index had lost 4.84 per cent the year earlier, due to the panic around the eurozone sovereign debt crisis. During the next 12-month period, however, when the index rebounded by 10.74 per cent, IA UK Smaller Companies and IA European Smaller Companies were the two top-performing sectors, making 22.6 and 21.46 per cent, respectively. IA Sterling High Yield took third place.
Five of the 10 best-performing funds that year had a small/mid cap bias. These do not include the single top performer, ASI UK Unconstrained Equity, which made 44.59 per cent. Although this fund is in the IA UK All Companies sector, it can invest across the market cap spectrum and may increase its exposure to smaller companies, for example, if that is where it sees the most opportunities.
Things were slightly different in 2009. Although small caps still had a fantastic year, with IA UK Smaller Companies and IA European Smaller Companies making 50.18 and 37.39 per cent respectively, this was only enough to put them in fourth and seventh position out of all the IA sectors. This can be attributed to the severity of the damage caused by the financial crisis, which was matched by the strength of the rebound when it eventually arrived.
The top-performing sector that year was IA Global Equity Income, with gains of 57.22 per cent.
The rebound from the financial crisis continued into 2010. During this calendar year, the three top-performing sectors were IA North American Smaller Companies, IA UK Smaller Companies and IA European Smaller Companies, with respective gains of 33.05, 31.56 and 25.94 per cent.
Best-performing sectors in 2008, 2009 and 2010
Source: FE Analytics
However, the list of best-performing funds that year was dominated by those with exposure to gold, accounting for five of the top-six places. Second-placed Slater Growth, which made 76.68 per cent, is in the UK All Companies sector, but has a high exposure to small and mid caps.
FundCalibre managing director McDermott is one who thinks small caps could be poised to outperform larger companies next year, should the global economy start to recover as hoped.
“Larger companies have been outperforming of late, helped in no small amount by the big tech names, which have been responsible for some 70 per cent of stock market gains this year in some countries,” McDermott said in a recent Trustnet article.
“Smaller companies, which have paid the price of investor uncertainty in 2020, have relatively attractive valuations and should do well going into a recovery.”
The elephant in the room is that although small caps tend to lead the market during periods of recovery, they also fall the hardest when it crashes.
IA European Smaller Companies and IA Japanese Smaller Companies were the first- and third worst-performing sectors in 2018, down 15.46 and 12.41 per cent, respectively. IA European Smaller Companies was the third worst performer in 2011 and 2008, while IA UK Smaller Companies took bottom spot in the latter period.
And of course, just because small caps have had a down year, it doesn’t mean they are guaranteed to bounce back the next time around. IA UK Smaller Companies and IA Japanese Smaller Companies both lost money in 2007 before they were hammered by the crash of 2008.