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Flight to quality

Given my concluding thoughts last week, it was something of a coincidence that I was required to look into the relative performance of smaller companies funds compared with those targeting the market leaders. This is no mean task.

The UK All Companies sector embraces all manner of approaches and portfolio types so taking the bare statistics from this sector to compare with the altogether more targeted UK smaller companies funds is not necessarily meaning-ful. Even so, it made interesting reading.

Most investment advisers are well aware how comprehensively mid-cap and smaller companies have trounced the market leaders over recent years. Even in the recent bear market, mid-cap stocks outperformed. Since then, their progress has been quite remarkable, with smaller companies trailing but still proving a better hunting ground for investors than the constituents of the FTSE 100 index.

Mind you, this is where the distortions become apparent. The best-performing funds over the past three years in the UK All Companies sector have been those targeting the mid-250 companies. This is why you have to be so careful when it comes to using statistics to prove a point. Moreover, the different approaches and styles adopted by managers will also influence performance. And there is little doubt different market conditions favour differing investment styles.

The reason this appears interesting at the present time is because of the contention that, during periods of uncertainty it is better to stick to quality. And quality is best represented by market leaders. Yet the FTSE 100 index is as diverse a group of potentially volatile companies as you are ever likely to find. Can they truly be said to represent quality?

Then again, does quality – which investment managers appear to be using as a euphemism for relative safety – exist in cash deposits? Depositors at Northern Rock did not think so, at least they didn’t until the Government stepped in to guarantee their savings. And what about bricks and mortar? In the US, house prices have fallen while back home they appear to be stagnating. At least housing is underpinned to a certain extent by replacement cost and a benign (for the investor at least) supply/demand situation.

The reason for dwelling on what might constitute a “quality” investment is to try to rationalise the robust performance of the stockmarket at a time of such extreme uncertainty. The extent of the write-offs the major banks have felt obliged to disclose clearly demonstrates the size of the credit problem. Yet when Citigroup announced they had taken a $6bn hit last week, the shares rose.

Quality in the current climate is a subjective judgement. Each manager will have his or her own assessment of the risks inherent in the current market. The disclosure of where these complex financial instruments have ended up will aid matters through introducing more transparency but that does not mean credit conditions are likely to ease any time soon.

Brian Tora ( is principal of The Tora Partnership


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