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Small talk

It hardly feels as though I have been away. The market is little changed overall. There is still conflict in Libya. Worries over economic progress continue. The future remains obscure. Yet quite a lot happened in the past month. What better time to take the temperature of the investment community.

I was chairing a webcast last week at which representatives from Aberdeen Asset Manage-ment, BlackRock, JP Morgan and Morningstar were present. The theme was smaller companies but the managers were all experienced and their views on current conditions were as relevant as those of large-cap managers.

It became clear that while corporate Britain appears in rude health and valuation levels undemanding, uncert-ainty and adverse sentiment are making forecasting future trends difficult. There was a degree of qualified optimism present around the table. How that optimism might translate into profit in the short term is a tougher call to make.

I have always had a soft spot for the small-cap sector. Aside from having served on the board of a smaller companies investment trust, some of my most successful personal investments have been in small caps. And they can be more fun, even if the business of monitoring your stake can be more demanding due to limited research material.

There were some interesting anecdotes to be shared with our audience. JPM’s Georgina Brittain mentioned UK firms benefiting from the mining boom in Australia and told the story of one smaller company that she considered efficiently run achieving a remarkable level of cost-cutting to head off the problems created by the downturn in economic activity. And takeover activity is more likely at this end of the market, she feels.

Ed Beal, manager of the Dunedin smaller companies, cited the income-generating powers of small caps. Not only are attractive yields available but risks appear less, with a wider spread of companies contributing to the dividend flow than exists in the FTSE 100. Look what happened to income distributions from the likes of BP and the banks.

Some of the best growth stories exist at this end of the market, according to Black-Rock’s Mike Prentis, and certainly 10-baggers, as those shares that have made you 10 times your original investment are known, are more likely to exist among smaller compan-ies than the industry giants.

But there is a perception that small caps are riskier and a vote among the largely IFA audience cited volatility as the principal concern. But that is why many advisers access the sector through a collective investment – for diversification and, it is hoped, to reduce risk.

Performance comparisons produced by Morningstar’s Jackie Beard showed that where a specialist manager runs both an open-ended and a closed-ended fund alongside each other, the closed-ended one comes out on top.

Perhaps this should come as no surprise. After all, small caps can suffer from liquidity issues and if, as a manager, you are forced to make sales to fin-ance redemptions, you might have to sell shares you would rather keep, just because they are marketable. The manager of an investment trust does not suffer these pressures.

I was cheered by immersing myself in the bottom-up approach this sector demands. Too much top-down news is negative these days. There are issues to be taken into account. The strength of the dollar, for example, or Japan slipping back into recession. But in the end, it is picking the right share that really counts.

Brian Tora is an associate with investment managers JM Finn & Co



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