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Adviser Fund Index: Misery loves small caps

There is a good reason why this has become known as the miserable rally – no-one seems to be in it. And for those who are, they are holding nice, sensible, defensive things like large companies, so they have missed out on the phenomenal performance of smaller companies.

As City Asset Management chief investment officer Hilary Coghill says: “In the AFI adviser fund index, I do not have a dedicated smaller companies holding. In the last six months, I have wished that I had.”

The question is whether investors are too late to get into the small-cap recovery story.

The share price performance of smaller companies in Britain has been off the charts. In the past six months, the FTSE smallcap index, which covers companies outside the FTSE 350, has risen about 65 per cent, while the FTSE 100 has made gains closer to 30 per cent. Even the FTSE 350 has outstripped the FTSE 100.

Is it too late to buy into the rally? There is an argument that this is less of a boom than bounce. In 2008, smaller companies had their worst year since 1974, and had fallen to such a low level there was nowhere else to go.

Coghill says: “Some of the cyclical companies in the sector were priced to go bust but they did not and the consumer held up well because the oil price fell and their mortgage repayments fell, so they still had disposable income.”

There was not anything particularly positive in the market – small caps were just priced for the worst-case scenario and that worst case never hit, so they bounced. That is one reason why so few investors bought into the market at the bottom – there was no compelling reason to do so.

Most AFI panellists did not have a specific small-cap exposure, with most preferring to hold funds that have the freedom to invest in smaller companies when the timing is right, such as special situations funds.

The panellists are in no great hurry to buy into the smaller companies rally either.

AFH Independent Financial Services head of investment research Graham Toone says: “They have had a fantastic run and they are fair value now. I would not have said they were a roaring buy and our strategy is neutral.”

In the medium term, panellists expect market conditions to remain tough. “Funding will be very difficult,” says Coghill. “The companies that get access to capital at reasonable rates are likely to be much stronger than those who do not. A lot of Aim-listed companies are saying that funding is still very expensive.” Trading will be lacklustre, says Coghill. “A lot of smaller companies are very domestic-oriented and we are fairly negative on the UK economy,” she adds.


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