Why small stocks could help you sail through choppy waters

SOME say small is beautiful, but if you have ever been on a yacht in a big storm, you will know it can be stomach-churning as well.

That is why some investors avoid buying smaller company investment funds – more volatile investments than those invested in FTSE All-Share Index stocks. But others actively court them, liking the potential for picking winners in sectors such as healthcare and technology.

Teodor Dilov is fund analyst at wealth manager Interactive Investor. He says: ‘Small stock market listed companies tend to outperform larger companies over the long term because they have greater growth potential. But with the Brexit transition period, recession and so many other unknowns, it could well be a bumpy ride for many UK smaller companies.

‘These are difficult times and investors may need to put their lifejackets on, but UK smaller companies have historically been a natural home for brave, contrarian, longterm investors.’

So is the future of investing in the UK stock market big or small? Many experts make a strong case for having some small-cap stocks in your portfolio, especially if they are being picked by expert fund managers.

Juliet Schooling Latter, research director at fund expert Chelsea Financial Services, believes there is a plethora of smaller company focused funds available, backed by ‘excellent’ stock pickers.

Being small in a Covid world

DESPITE long-term outperformance, UK smaller and medium sized companies have lagged behind their larger cousins since the beginning of this year.

Guy Anderson, manager of investment trust Mercantile, says the FTSE 250 Index has underperformed the FTSE 100 because of its greater exposure to the UK economy. He adds: ‘The performance of smaller companies is more geared to the UK economy and domestic consumer spending.

‘The large market cap universe is more heavily weighted towards sectors such as financials, energy and healthcare. The mid and small cap universe leans more heavily towards the consumer discretionary and industrial sectors.’

These are sectors, he argues, that have struggled since Covid-19 hit, but their drag on general smaller company performance has not prevented some stand-out corporate stars from emerging.

Anderson says: ‘Many speciality retailers in the mid cap space, such as Dunelm, the homewares retailer, and Games Workshop, which makes miniature figurines for wargames, have benefited in this environment.

‘The retail discounter B&M has also been a winner. Despite an uncertain domestic outlook, there are pockets of investment opportunity in the mid & small cap space that deserve investor attention.’

Keith Bowman, an analyst at Interactive Investor, points to the likes of Premier Foods as an example of a ‘good’ smaller company stock – its share price is up 124 per cent since the start of the year. The company, embracing household brands such as Bisto and Mr

Kipling, has been boosted by more people cooking at home. Logistics group Clipper is another standout smaller company star. Its share price is up 19 per cent this year, 128 per cent since lockdown began in late March.

Bowman says: ‘Clipper’s customers include Tesco, Morrisons and the NHS. The push to online retailing as a result of the pandemic is providing a following wind to current trading. Despite some initial disruption, Clipper has seen business increases of more than 100 per cent on a like-for-like basis with some customers.’

Firms with the power to act fast

ONE of the main reasons why some managers like smaller companies is their ability to act fast and take advantage of business opportunities, which can be more difficult for bigger companies.

Roland Arnold is manager of investment trust BlackRock Smaller Companies. He likes to invest in companies that have strong balance sheets and have the ability to move fast when business opportunities present themselves.

He says: ‘Although the timing and path of the economic recovery is uncertain, I am confident that entrepreneurial-led smaller companies will be the first to adapt to the challenges ahead. Many, benefiting from streamlined management structures, will tilt their businesses to take advantage of the inevitable opportunities that will come their way, and emerge in a stronger competitive position.’

Jonathan Brown, manager of investment fund Invesco UK Smaller Companies Equity, is concentrating on those that should do well no matter the economic climate.

He has bought veterinary firm CVS – an AIM-listed company – that he says should benefit from the increase in pet ownership post lockdown. Also, defence business Ultra Electronics – FTSE 250 listed – which Brown says ‘provides key products that address the increasing threat of Chinese submarines in US waters’.

Brown is also hoping to benefit from key investments in computer gaming, a sector that British firms thrive in. He likes Keywords Studios that offers services such as art creation, games testing and language translation to the computer gaming sector.

How investment funds have fared

INVESTMENT trust analysts at QuotedData have crunched the performance numbers for smaller company investment trusts over the past six months. Those with a strong bias towards healthcare stocks have performed the best, benefiting from renewed interest in healthcare due to Covid.

Oryx International Growth leads the way. Over the past six months, its share price has increased 4 per cent – 19 per cent in the past three months. Key investments include EKF Diagnostics, which is contributing towards Covid testing, and Ergomed which has been assisting in trials of therapies for Covid.

James Carthew of QuotedData also singles out BlackRock Throgmorton. He says: ‘In addition to a good track record of picking winning stocks, manager Dan Whitestone can also short shares in companies that he thinks face insurmountable challenges. Both parts of this investment formula have done relatively well.’

Schooling Latter likes Gresham House UK Micro Cap and Marlborough UK Micro Cap Growth – funds that typically invest in stocks with market capitalisations of less than £150 million.

The Gresham House fund has a financial services bent with the main holdings including legal services group Knights and pension group XPS. Marlborough’s top holdings include meal ingredient delivery service Gousto which has done very well from lockdown.

Interactive Investor’s Dilov is a fan of trust Henderson Smaller Companies. He says: ‘Manager Neil Hermon is a renowned smaller companies investor with a strong team behind him with a focus on buying growth stocks at the right price.

Dilov also likes Amati UK Smaller Companies which he says ‘has a good record and looks for poorly researched companies that may offer good opportunities’. Amati runs a portfolio of 70 companies and has several financial services and asset management businesses in its top holdings – including Intermediate Capital and Liontrust. It also has a number of healthcare stocks.

The future for the little and fierce

WHILE Brexit, recession, unemployment and coronavirus issues will bear down on the UK economy in the coming months, there are certainly investment gems to be found outside the FTSE 100 Index.

With a talented stockpicker on your side, there’s no reason why you should not think small.