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The big cap fits

Matt Goodburn considers the potential for large-cap stocks

In recent months there has been a general consensus among UK fund managers that large caps are set for a period of outperformance after a few years of relative underperformance relative to their small and mid-cap counterparts.

But F&C UK opportunities fund manager Phil Doel is not sure that the very biggest companies in the market are the best bet even though he agrees they look cheap.

He says: “Although the FTSE Allshare index has 687 constituent companies, the top 20 stocks currently account for around 53 per cent of the market. These mega caps are in sectors such as banking, pharmaceuticals and oil that are facing pressures in terms of growth, rising costs and seemingly continuous regulatory scrutiny.”

Doel also believes that mega-cap stocks could see growth prospects curbed because they are too big to be the subject of takeover activity.

He says: “Having spent the last few years tidying up their balance sheets, companies globally are now switched into growth mode and there is a clear appetite for transactions.

“However, we believe the very biggest stocks are mostly out of reach of either private equity or corporate predators and at that end of the market we are more likely to see some break-ups and disposals.”

Baring Asset management head of UK retail Charles Deptford says he does not expect mid and small caps to continue to perform as strongly as they have since 2003 and says he thinks it is still hard to find better value in the mega caps.

He agrees that the sheer scale of the mega caps makes them unlikely to be the subject of corporate activity but believes the question of which area will outperform depends on whether fund managers and analysts believe the market will go up or down.

He says: “There is a general net disinvestment in large caps because they are big and liquid stocks but if you believe the market will continue to go up a lot and economic growth will continue then small and mid caps are likely to outperform.”

“But it is fair to say that most large caps are relatively more defensive so if the economic outlook is not as strong, you would expect to see the mega caps outperform.”

Deptford believes valuations in the FTSE 100 are not too extreme and that there has been decent recent performance among the biggest companies.

He says: “This year, pharmaceuticals and oil and gas have underperformed but the big banks have done quite well. Vodafone and Barclays have had a very good recent run while HBOS is up by 16 per cent in the last 12 months so there are good growth stocks in that part of the market.”

Scottish Widows Investment Partnership smaller companies manager Chris Banbury says internal Swip research has revealed that the best-performing shares currently are stocks with a market cap of between 350m and 750m.

He agrees that, barring any downturn and a subsequent flight from risk, they could continue to do well.

“Small caps are currently on a 25 per cent premium to large caps, which is normally as far as it goes,” he says.

Standard Life Investments UK opportunities fund manager Mark Niznik also thinks it is easier to get better growth rates from small and mid-cap stocks. He says: “Over the last 50 years, small caps have outperformed large caps by an average of 3.5 per cent and almost twice as often as large caps.”

Niznik says small and mid-cap stocks are at their highest values for 30 years. He says when the fund was launched four years ago he was more bullish than currently because of the price of small cap stocks and cites statistics provided by broker Hoare Govett.

“The smaller companies index says small caps are trading on 17.4 times earnings compared with large caps which are at 13.7 times so on the face of it they are trading at a 27 per cent premium whereas when we launched the small fund four years ago, they were at a 30 per cent discount,” he says. However, Niznik says the prices are distorted by the fact that there are no lossmaking companies in the FTSE 100.

He says: “It is incredibly difficult to say which will perform better in the long term but I am happy to stick too my long-term strategy that there is more money to be made in small and midcap investing.”

SVM UK opportunities manager Neil Veitch also believes there are plenty of opportunities to find growth in the relatively underresearched universe of small and mid caps although they are becoming harder to find than previously.

He says: “The good recent performance of the fund has been generated by mid caps but it is getting more difficult although there are still good growth opportu-nities in the small-cap and Aim markets.”

Veitch is also wary that talk of large caps being set to outperform the index could be driven by some of the big fund management firms because it is more suited to their stockpicking process.

He says: “Mid caps have done very well, and it is all too cosy for some fund managers to suggest that because they have had a strong run they are now overvalued.”

Merrill Lynch UK special situations manager Richard Plackett believes the outperformance of the small caps is partially driven by large caps buying small caps.

Plackett’s special situations fund is currently 40 per cent invested in large caps and 60 per cent in small caps and although he cites banks and resources as mainly undervalued large-cap stocks he still believes that small caps have greater potential.

He comments: “You should always be overweight in small caps because you have more chance of finding growth.”


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