Over the longer term, UK smaller company funds generally outperform blue-chip funds. While smaller companies have performed particularly well over the past year, some well-managed UK smaller company funds should continue to outperform the FTSE 100 index.
Over the past 48 years, the UK small-cap index has outperformed large caps by 3 per cent a year. This means that if you had put money into smaller companies, you would now have more than five times more money than if you had invested in the FTSE 100.
The main reason for this outperformance is that smaller companies are more dynamic and can adapt to fast moving worlds.
Over the past five and 10 years, the average smaller company fund has risen by 53 per cent and 102 per cent respectively against a loss of 5 per cent over five years and a profit of 76 per cent over 10 years for the average UK all companies fund.
The best managers make money by investing in undervalued companies which have a strong market position, with little prospect of other companies being able to enter their niche positions.
The companies should also have strong balance sheets, an ability to generate cash and, above all, a dynamic and enterprising management team.
The funds I like best are those valued between £50m and £200m where the managers have a proven performance record over three to five years, such as Merrill Lynch UK smaller companies, Old Mutual UK smaller companies, Framlington UK smaller companies, BWD UK smaller companies and – an exception to the fund size rule – the smaller BWD UK microcap growth fund, managed by the excellent Stuart Sharp.
This year, it has increased by 99 per cent and, with Sharp's stock selection skills, might well continue to do very well.