Small looks to be more beautiful by the day in the markets

Harry Nimmo is one of Britain’s must successful stock market fund managers. Investors who bought into his Standard Life UK Smaller Companies Investment Trust in recent years have done astonishingly well.

Even after the plunges of the past two months, shares in the trust are still 42 per cent up over the year to the start of September, they have doubled over the past three years and are up 133 per cent over five years.

Now investment in smaller companies is widely viewed as more volatile and risky than a fund investing in the big FTSE 100 behemoths. Large companies are seen as more resilient, with a larger share of their markets and greater spread of activities to help them ride out the sort of storms we have recently experienced.

Nimmo’s success has been based on shrewd investment in smaller companies. They tend to be more innovative and opportunistic in developing new technologies. They are also capable of moving fast and many enjoy strong growth on the basis of specialist knowledge and experience of niche markets.

Most investors recognise these attributes but feel that the risks of capital loss are greater. Many prefer the perceived safety of a portfolio of investments spread across established household name companies with large market capitalisations and solid looking dividend yields.

“Mind your eye” is the retort from Nimmo. The perception that large companies are less volatile, more stable and “safer” is an illusion.

In an interview with FE Trustnet reporter Joshua Ausden at the weekend, he argues that the reign of the “stable large caps” is over. Many FTSE 100 stocks, he argues, are more risky than their small cap counterparts.

So far this year, he points out, the average FTSE Small Cap stock has been 0.43 per cent less volatile than the average FTSE 100 stock.

“To be honest,” he said, “I think large caps are actually more risky than small caps these days. Banks have been a total disaster, and if you look at mining stocks, some of these have been absolutely slammed. Of course, there are plenty of high-risk small caps as well, but we don’t invest in them.”

Nimmo’s words are a timely warning that “big” in stock market terms is not necessarily “safer”. The investment landscape in recent years has been littered with spectacular collapses of leading companies. Few sank more dramatically than Cable & Wireless, which took an impressive cash pile and lost it. Many large companies that caught the information technology bug disappeared without trace.

More recently, as the FE Trustnet article points out, so-called “too big to fail” large cap stocks have suffered huge losses. Lloyds and RBS – widely favoured for their “rock solid” dividend yields – have both lost more than 88 per cent in the past three years – and have notably been back on the slippery slope in recent weeks. Oil giant BP, another dividend stalwart in many large cap funds, has lost almost 15 per cent. The recent volatility in the equity market has also hit big blue chips harder. And despite the marked volatility of commodity and natural resource stocks – caught in the eye of global forces such as the continuing surge of Chinese demand, the gathering economic slowdown across America and Europe and the resorting to quantitative easing which has helped to inflate commodities prices – the vast majority of investors still view small caps as significantly more volatile than large caps.

The investment trust performance tables seem to bear out the story of greater resilience achieved by funds specialising in investment in smaller companies.

Over the past 12 months, the investment trust UK smaller companies sector is still showing a gain of 23.2 per cent. Nimmo’s Standard Life Investments UK Smaller Companies Trust topped this sector with a 42.4 per cent gain over the year – remarkable given the signs of overall economic slowdown evident since early on in the year.

This is a £142 million trust whose top ten holdings include Asos, Abcam, Hargreaves Lansdown, Telecom Plus, Renishaw, New Britain Palm Oil and Rightmove. Indeed, so popular is the trust that its shares, at 218.5p, are now standing at a premium to net assets of 3.48 per cent – a rating that may discourage seasoned hands in the sector.

Nor is Standard Life’s UK Smaller companies trust a rogue one-off. In fact, it is one of four investment trusts specialising in the smaller companies sector in the top 40 of all investment trusts graded by performance over the 12 months to the start of September.

These are BlackRock Smaller Companies Trust (up 29.8 per cent); Dunedin Smaller Companies Investment Trust (27.7 per cent) and Montanaro UK Smaller companies (26.8 per cent). Such performance by no means renders them invulnerable to the turbulence being experienced in markets. But it highlights an often overlooked vulnerability of mega companies.