Small but mighty? Investing in smaller companies

When you hear stock market news, there’s often some mention of a tech goliath such as Facebook or Google. But as Goliath found out, bigger isn’t always better.

Small caps are shares in the smallest companies on the stock market. Because of their size they’re typically innovative and agile. If they spot an opportunity they can be quick to seize it.

Small companies often specialise in one thing, sometimes quite niche. With this focus, they could become the very best at what they do. It means smaller companies can have great potential, but also increases risk as inevitably not all will succeed.

Small companies often make their money in new and dynamic industries. Even if their area is an established one, they can disrupt it by offering an inventive solution. An increase in their market share often follows.

All this points to one thing: small companies have the chance to grow faster than large ones.

No surprises then that small caps have tended to do better than their larger peers in the long run. But they have usually fared worse when the economy turns sour. This makes their share prices more volatile. Despite generally doing better, small caps tend to have larger swings in price.

Small versus large companies – 20 year performance

Past performance isn’t a guide to future returns. Source: Lipper IM to 30/04/2018.

Large companies have their every move pored over by analysts, whereas smaller companies are generally under-researched. Opportunities await those prepared to sift through them. Hidden gems are waiting to be found.

But it’s difficult for ordinary investors to find out about smaller companies. And there are hundreds of them in the UK to consider. So how can you find the potential stars of the future?

We think the best way to invest in this area is with a specialist small cap fund. The fund managers find what they think are the best small companies on the market. So you’ll invest in a lot of companies, chosen by an expert.

The most talented managers in this sector have shown great long term performance. But remember that all investments will rise and fall, so you could get back less than you put in.

Marlborough Nano-Cap Growth

Giles Hargreave is one of the most successful small cap fund managers in the UK. He runs Marlborough Nano-Cap Growth alongside his team. By surrounding himself with such a strong and experienced team, no stone is left unturned.

Their view is the smaller the company, the greater the growth opportunity. So they hunt for the best companies at the smallest end of the market. This makes the fund different from most others.

With around 165 holdings it’s a diverse fund. Its largest investment, Frontier Developments, is a video game creator and is developing the latest Jurassic World game.

Exciting technology companies are the single largest sector within the fund. As all the companies are so small they can take many years to reach their full potential. That’s why Hargreave invests in them for a long time – typically at least ten years. Investors in the fund should take a similar long term view.

Malborough Nano-Cap Growth – performance since launch

Past performance isn’t a guide to future returns. Source: Lipper IM to 30/04/18

Past performance isn’t a guide to future returns. Source: Lipper IM to 30/04/18. *Full year performance data not available

The fund’s performance since its 2013 launch has been excellent, significantly beating the FTSE Small Cap index. It’s one of our favourite funds to invest in smaller companies, but that doesn’t mean future performance will match that of the past.

FIND OUT MORE ABOUT MARLBOROUGH NANO-CAP GROWTH, INCLUDING CHARGES AND HOW TO INVEST

MARLBOROUGH NANO-CAP GROWTH KEY INVESTOR INFORMATION

Standard Life Investors UK Smaller Companies

Harry Nimmo, manager of the fund, rides his winners. As small companies grow into large ones, many small cap fund managers will sell the shares. Nimmo will keep them as they keep growing. That’s why his average company size is larger than most other small cap funds.

Take NMC Health for example. They’re one of the largest private healthcare providers in the UAE. Since the fund has held it, the company has grown so large it’s now part of the FTSE 100.

The fund invests in around 50 companies. This means each one can have a bigger impact, both positive and negative, on the fund’s performance. The manager likes companies that make money steadily and reliably. He only picks them if he’s confident this dependable income will continue in the years ahead. He also has the flexibility to use derivatives, which if used, increases risk.

Standard Life Investors UK Smaller Companies – performance since launch

Past performance isn’t a guide to future returns. Source: Lipper IM to 30/04/18

Past performance isn’t a guide to future returns. Source: Lipper IM to 30/04/18.

As well as having one eye on the future, he keeps one eye on the past. He prefers companies that are either run by the founders, or where the management team has been in place for at least ten years. Since it ties management to the long-term goals of the business, we like this approach.

The fund has beaten the broader market of UK smaller companies by a healthy margin over the long term. As with any investment, past results don’t indicate future performance.

FIND OUT MORE ABOUT STANDARD LIFE UK SMALLER COMPANIES, INCLUDING CHARGES AND HOW TO INVEST

STANDARD LIFE UK SMALLER COMPANIES KEY INVESTOR INFORMATION

This article isn’t personal advice. If you are unsure of whether an investment is right for you, we can offer you advice.