Investment trust insider on small caps – James Carthew: The world can’t be mean to small-caps forever
The dominance of mega-cap tech stocks has exacerbated the underperformance of smaller company funds, but history suggests this should change.
Mean reversion, the tendency for asset prices to return to their long-term average, is a wonderful thing. However, sometimes the pendulum swings so far in one direction, it can feel like things are never going to come right.
One example of this currently is the relative underperformance of smaller company stocks versus large caps in many parts of the world.
Small caps are usually reckoned to outperform larger stocks over the long term. A simple explanation for this is that they have a greater potential for growth. ‘Elephants don’t gallop,’ as Ashe Windham, chair of Miton UK Microcap (MINI), said recently.
There is a risk/reward argument for this too. Small-cap stocks are riskier than large caps for a variety of reasons. For example, they are less well-capitalised and so more vulnerable to downturns, find it harder to obtain debt finance, are more dependent on a single product or service, and more reliant on founders and key persons.
Rational investors – of whom there don’t seem to be many – should demand a higher return for backing a riskier company.
In the UK, the FTSE Small Cap ex-Investment Trust index outperforms the FTSE 100 over most time periods. In terms of underlying growth in net asset value (NAV), over 10 years the median UK small cap trust Henderson Smaller Companies (HSL) has returned 108%. In the UK All Companies sector the median trust is Aurora (ARR) which has returned 74%.
However, the smaller end of the small-cap sector – AIM stocks and microcaps – has… read more here