Fortune favoured smaller companies at last in April, as funds and investment trusts holding them bounced back after a torrid time.
Their rebound came after smaller companies were battered by the coronavirus stock market storms in February and March, falling harder and faster than shares in larger firms.
Smaller companies are known to shine in recovery, but investors are asking whether it’s different this time as coronavirus leaves large parts of the economy all but shut and bigger firms may be better placed to ride out lockdowns and tap into government help.
Smaller companies funds across the globe have been extremely volatile since February
During the stock market falls between February and March this year, the [smaller company-focussed Russell 2500 fell some 9 per cent more than the S&P 500 while in Asia and emerging markets, smaller companies fell by 8.5 per cent more than larger companies.
Meanwhile during the two months to 1 May, there was a drop in every smaller companies fund and investment trust sector listed by the IA and AIC, respectively, except for Japanese Smaller Companies.
Falls ranged from an 8.5 per cent drop for IA European Smaller Companies to a 17 per cent fall for the AIC North American Smaller Companies sector.
But figures are now looking more positive despite Covid-19 still remaining a threat across the globe and millions of smaller stock market-listed businesses being potentially at risk of not surviving the pandemic.
The FTSE Small Cap index is down 11 per cent since the start of 2019, versus a drop of 14 per cent for the FTSE 100.
This reflects the make-up of the UK market, with a bias towards energy and financial stocks, which have both been hit hard recently.
Despite their more volatile prices, smaller companies are often perceived to provide the best opportunity for returns over the long-term, but at the moment investors may need to be cautious.
Darius McDermott, managing director of FundCalibre, said: ‘Smaller companies can be an excellent investment for investors with a long-term investment horizon and who are willing to take on more risk and the valuations are certainly more compelling right now.
‘However, this recession is likely to be very deep, and no one knows how long it will last, so there are bound to be many businesses that struggle and go bust.
‘That said, there are always winners, and those that do survive could find themselves in much stronger positions going forward.’
“As always, good stocking picking skills will be paramount, and investors might like to consider smaller monthly contributions rather than a larger lump sum at this stage.”
Fidelity’s Tom Stevenson said larger companies may be more favourable
Tom Stevenson, of Fidelity International, also highlighted that economic recovery does tend to favour smaller and more out-of-favour stocks, as seen following other market downturns such as the global financial crisis.
However, he noted the uniqueness of the current situation and certain factors that are putting extra pressure on smaller companies.
‘Small businesses will likely face difficult decisions about whether they can afford to keep staff employed once the Government’s furlough scheme comes to an end.’ he said.
‘It might make sense to rotate more to the smaller end of the market, however, a recovery is likely to be more protracted and shallower than investors initially hoped.
‘This explains the change in sentiment at the beginning of this month. In a slower, flatter recovery, investors will continue to favour big reliable companies with pricing power. This argues for larger rather than smaller companies.’
A recovery is likely to be more protracted and shallower than investors initially hoped
Tom Stevenson, Fidelity
Meanwhile, Lee Wild, of Interactive Investor, also warned the worst may not be over yet, amid concerns that the coronavirus support on offer may favour bigger firms.
He said: ‘No one truly knows what will happen next, but a U-shaped or W-shaped recovery seems more likely than a dramatic V-shaped rebound.
‘There is little doubt that April was one of the best months for returns in living memory, certainly for hard-hit small-caps, but it is important to remember that another sharp fall not beyond the realms of possibility as the true economic impact of the pandemic remains unknown.’
|IA European Smaller Cos||14.46||-8.46||-13.57||-3.72||28.86||120.74|
|IA Japanese Smaller Cos||11.42||1.49||-8.02||11.05||60.91||161.85|
|IA North American Smaller Cos||17.57||-8.24||-13.11||12.69||53.83||175.34|
|IA UK Smaller Cos||13.48||-13.51||-22.00||-2.56||28.10||151.00|
|AIC UK Asia Pac Smaller Cos||9.11||-16.34||-21.00||-19.64||-2.16||98.25|
|AIC European Smaller Cos||18.00||-8.66||-17.20||-0.58||42.12||160.58|
|AIC Global Smaller Cos||15.98||-2.84||-9.15||3.40||12.88||156.17|
|AIC Japanese Smaller Cos||10.49||3.63||-10.95||25.91||65.83||202.37|
|AIC North American Smaller Cos||15.53||-17.04||-24.47||-1.60||42.04||117.17|
|AIC UK Smaller Cos||11.53||-14.08||-24.89||-8.38||28.08||172.89|
|Source: FE Analytics (Total return in sterling)|
A recovery for smaller companies is likely to look different on a country by country basis too.
For example, there has been a significant performance shortfall by smaller companies in the US. Since the start of last year, the S&P 500 is up 13 per cent while the Russell 2000 smaller company index is down 7 per cent.
Meanwhile, Japanese small-cap funds haven’t been hit as hard since the pandemic started impacting markets, while those investing in Europe or the UK have suffered extreme volatility.
Smaller company funds were down, on average, by 13.5 per cent in March, though this has almost completely turned around since. Smaller company investment trusts haven’t quite recuperated their March losses yet.
Georgina Brittain manages a number of small and mid-cap funds at JPMorgan AM
Small and mid-cap specialist and fund manager at JPMorgan Asset Management, Georgina Brittain, said both her £173million JPM UK Smaller Companies fund and £178million JPM Smaller Companies investment trust suffered in February and March, due to the FTSE 250 being hit particularly hard.
She said: ‘We run a fairly concentrated portfolio, which tends to suffer more in the short term.
‘However, in the main we have chosen to maintain what we believe is a portfolio of long-term winners, and we believe this will be borne out over time.
‘We have tried to keep a balance, after rigorously analysing the balance sheets of our investments, so that the funds can benefit on the way up when markets do rally.’
In order to protect both portfolios she has reduced exposure to consumer-facing companies, and increased exposure to individual companies where she feels the market has ‘overreacted’.
She added: ‘As you would expect, we have gone through all the companies we own to try to ensure that they will prove to be the long-term winners, who will come out of this experience stronger than before.’
Small cap fund ideas
By Darius McDermott of FundCalibre
Marlborough UK Micro-Cap Growth
This fund invests in small and micro-sized companies and is run by the very experienced, astute and pragmatic stock picker Giles Hargreave. He is supported by co-manager Guy Feld and a well-resourced team of fund managers and analysts.
T. Rowe Price European Smaller Companies Equity
This pan-European fund also invests in the UK, and has a highly experienced manager, with a proven track record managing small and mid-cap portfolios in Europe. Buying early or in a contrarian fashion with a long-term view allows him to compound his winners.
Miton US Opportunities
The managers of this multi-cap fund have the flexibility and pragmatism to adjust the portfolio to different market environments. It usually has a bias towards medium-sized companies and the managers have recently been adding to small-caps.
AXA Framlington Japan
This fund invests in Japanese companies of varying sizes but tends to have a slight bias towards smaller companies (currently 40 per cent of the portfolio). The manager looks firms with long-term growth prospects independent of what is going on in the wider economy.
Hermes Global Emerging Market SMID Equity
This is a concentrated fund focusing on small and medium-sized companies across global emerging markets. Launched in 2018, its co-managers look for quality companies with talented management, who act responsibly towards clients, stakeholders and shareholders.
ASI Global Smaller Companies
Based around ASI’s powerful screening tool ‘Matrix’, this fund identifies smaller companies from all around the globe – including emerging markets – that the managers believe to have the best growth prospects.
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