By Rob Morgan, Pension and Investment Analyst at Charles Stanley Direct
Investors sometimes overlook smaller companies when constructing a portfolio, perhaps distracted by more exotic overseas markets. Yet smaller companies offer the potential for strong returns. Over the past 20 years the IMA UK Smaller Companies sector has risen 444% compared to 294% for the UK All Companies sector, though smaller companies have been more volatile and past performance is no guide to the future. UK smaller companies have also beaten the IMA Global Emerging Markets, which is up 318%, showing it isn't always necessary to look overseas for superior long-term growth.
Smaller companies is also an area where good stock pickers can have a real edge. Not only is there a great range of companies to choose from, but they are less widely known by the City. Those prepared to go the extra mile can uncover valuable information and steal a march on the competition, helping drive returns.
The small and mid cap team at Old Mutual are particularly well-respected for their proprietary research. They are led by Ashton Bradbury, a highly successful fund manager, who now also contributes valuable macro-economic views. He explains that while many investors are puzzled that markets are pushing ever higher, it is a result of various risks receding. A slowdown in US government spending, a "hard landing" for China's economy and problems in Europe had all been reasons not to enter equity markets. However, those impediments have one by one disappeared, which has forced equity valuations higher.
He also points out that companies are generally in good shape with sound finances and increasing earnings. As such he believes valuations remain relatively attractive, and it is possible we will see double-digit returns in UK equities over the next year. However, it is important to be selective. Following such a great run he notes some company valuations already anticipate strong results. If these do not transpire share prices could be punished.
This, in theory, should play to the team's strength as stock pickers. Finding companies that continue to positively surprise the market (and avoiding those that disappoint) should lead to outperformance. The manager of Old Mutual Smaller Companies, Daniel Nickols, explains that there is a wide variety of stocks he believes can generate attractive returns from these levels.
Despite the tricky economic environment, there are some areas still growing strongly. Mr Nickols highlights Telecom Plus, a utility reseller capable of rapidly growing its market share, and Ashstead, a plant hire business expanding in the US. He also believes a number of more prosaic companies offering generous dividend yields look interesting. He notes that firms such as brewer Greene King, telecom provider TalkTalk, and storage firm Big Yellow all offer generous yields, which could also grow over the long term.
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