UK active manager makes the small-cap case
In putting a case for small caps, Gervais Williams, senior executive director at London-based active management house Miton Group, observes that the key differential between larger mainstream stocks and smaller, often overlooked stocks, is the latter’s ability to buck the wider economic trend.
‘While there are some larger companies that can sometimes grow well even at a time when their markets are stagnant, in general this is really hard to achieve for those that already have a large part of the market,’ Williams tells IR Magazine. ‘Not all smaller companies are well placed to take market share, but those that are typically start with a modest share so they can generate good growth even though the wider market may not be growing.’
Williams, who is speaking at the forthcoming IR Magazine Forum – Small Cap Europe in April, notes that despite the many headwinds the UK faces, it remains an appealing small-cap market. ‘In spite of the fact that the UK may be suffering a consumer recession and the Brexit negotiations aren’t going well, we still expect UK smaller company stocks to outperform again,’ he says.
‘While some larger companies may be flexible enough to take full advantage of the changes, in general we expect a much larger proportion of smaller companies to benefit. Alongside that, we believe many are still standing at undemanding valuations – so their upside potential could be larger.’
Another important point about this period of change is that it will favor the most corporately agile, which typically favors the best of the smaller stocks. ‘Clearly at some stage there will be an economic setback, and when it comes it could last for some time, as there is little scope to cut interest rates or for the [UK] government to take on a big budget deficit,’ Williams explains. ‘We believe quoted companies with negligible debt or net cash balances will be particularly well placed to take disproportionate advantage of the weakness of others at these times.’
Placing this into a wider political context, he adds: ‘It is interesting to note that in spite of a minority government in the UK, the risk of consumer recession, the first rise in UK interest rates for a decade and plenty of uncertainty over the Brexit negotiations, UK smaller companies outperformed during 2017, and indeed have continued to do so in 2018 to date. We believe this is in part down to the scope for smaller stocks to buck the wider economic trend, and hence should be a trend that persists off and on in the future.’
Investors have been slow to exploit the potential of small caps while the sun has been shining elsewhere, however. ‘Institutional investors have not greatly participated in small and micro-cap stocks over recent decades because the market returns in the mainstream equity markets have been so good,’ Williams says. ‘But the ultra-low level of bond yields currently implies that the returns on most asset classes may be subnormal over the coming decade. If this is the case, institutions will need to participate in the quoted smaller and micro-cap markets to a much greater extent.’