The rise of a neglected asset class
In the past, smaller companies were overlooked and undervalued, but is it time for investors to reconsider this less-favoured sector?
THEY MAY NOT have the allure of a Google or Coca-Cola, and while smaller companies may not be household names, they are beating the odds to provide decent returns. So is it time for investors to reconsider this less-favoured sector?
Patrick Lawless, managing director of Appian Asset Management certainly thinks so. His company has just launched its first smaller company fund, the Small Companies Opportunities Fund, and he is forecasting growth of 10 per cent a year.
“Our view is that smaller companies are overlooked, under-owned and now undervalued,” he says.
Fund manager Ken Nicholson, who runs Standard Life’s European Smaller Companies fund, agrees, noting that small caps are quite a “neglected asset class”.
The reason of course, is that investors perceive investing in smaller companies as a riskier proposition than sticking to household names and tend to stay away. But ignoring small caps might be to their detriment. In the UK, small caps have outperformed bigger companies almost persistently for nearly 60 years, according to research from the London Business School, while other studies suggest that over the long term, smaller companies have outperformed larger companies by the order of about 5 per cent a year.
In the UK, there is a whole movement emerging behind smaller-company investing, led by manager Gervais Williams. He is a proponent of the “slow finance” approach which, much like the “slow food” movement, advocates looking for investment opportunities – as opposed to strawberries – close to home. This means opting to put your money into small, local companies and he has even built an app to help you identify potential investments in your area, although it is limited to the UK.
And while the term “small” might put off some investors, it doesn’t mean that you’re betting your money on pre-revenue start-ups. Typically, small-cap companies span the spectrum from a market capitalisation of about €100 million all the way up to about €4 billion.
“We’re not really into investing in start-ups. We look for more established companies that have proven track records,” says Nicholson.
To mitigate the risks posed by investing in smaller companies, which because of their scale and their focus on a particular sector, can be a riskier prospect than a large, diversified global organisation whose business spans the globe, stock-picking is key. “You can find riskier smaller companies, but the secret of our success is to invest in sustainable ones that produce a strong return every year,” says Nicholson. And his fund’s results don’t lie. Over the past three years to September 30th, the European Smaller Companies Fund has returned more than 11 per cent a year on an annualised basis, surpassing 20 per cent over the past 12 months.
So how do they do it?
“We look for companies with strong balance sheets, low debt, strong cash flows and the ability to not only pay a dividend but also to grow it,” Nicholson says, adding that they favour family-run businesses, such as the French pen company, Société Bic, “as they’re the kind of companies that are in it for the long term”.
So, while you might not be investing in the next Google, sometimes it is the “boring” companies that can offer the most comfort. As Nicholson notes, the tag-line for Standard Life’s smaller company fund is “Proudly investing in boring companies since 2007”.