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Why Smaller Companies Funds Have Outperformed

The average UK smaller companies fund has comfortably outperformed the FTSE Small Cap and Numis Smaller Companies indices in 2017 so far

Samuel Meakin 18 October, 2017 | 12:34PM

The average UK smaller companies fund has comfortably outperformed the FTSE Small Cap and Numis Smaller Companies indices in 2017 so far, with the average fund returning 20.6% versus 12.6% for the FTSE and 14.9% for the Numis. Why is this?

There has certainly been a stylistic tailwind benefitting active funds in the period. The category average demonstrates a clear growth bias relative to the FTSE Small Cap index, and small-cap growth stocks as defined by Morningstar have outperformed small-cap value stocks in 2017 to the end of September. Nonetheless, the average fund has also been able to demonstrate strong stock selection on top of that to help drive home the gains over the index over this period.

When compared to the Numis index rather than the FTSE, the category average’s growth bias still remains, but it is less pronounced. The stylistic tailwind versus this index has thus been smaller, but attribution analysis again shows that strong stock selection has helped the average fund to outperform.

Is there a market-cap effect also at play? Partially. The average fund has benefitted from being overweight to mid-cap growth stocks, which include the likes of Renishaw (RSW) and Dechra Pharmaceuticals (DPH), common holdings among a number of small-cap funds that have contributed to returns this year. However, the difference in returns overall between the FTSE 250 and the FTSE Small Cap index in 2017 to the end of September has been small.

It is also worth mentioning AIM. Many smaller companies funds include significant allocations to AIM-listed stocks, and AIM has enjoyed a very strong run over recent times, with notable constituents including FeverTree Drinks (FEVR) and Clinigen (CLIN). Indeed, anecdotally we have noted a trend of small-cap funds expanding their maximum allowable allocations to AIM in the past couple of years.

Which Stocks Have Gained in 2017?

So where have the stock selection gains been made by active managers this year? Stock picking has been strong across a range of sectors, notably within the consumer space. FeverTree, for example, remains a popular pick among UK smaller companies fund managers and the stock has continued its upward trajectory this year. albeit coming off the highs more recently. Within technology, FDM Group (FDM) is another popular holding that has contributed strongly this year.

Avoiding significant fallers is also an important part of an active fund manager’s role, and they have had some success in doing so this year. For example, within the real estate sector, generally steering clear of estate agencies Foxtons (FOXT) and Countrywide (CWD) has been positive for active stock selection. Similarly, avoiding Imagination Technologies when it lost its contract with Apple helped the average fund.

These examples demonstrate how active management can add value in the smaller companies space. Nonetheless, there remains wide dispersion in the performance of the best and worst performing funds, underscoring the importance of sound fund selection when allocating capital to this space.

The information contained within is for educational and informational purposes ONLY. It is not intended nor should it be considered an invitation or inducement to buy or sell a security or securities noted within nor should it be viewed as a communication intended to persuade or incite you to buy or sell security or securities noted within. Any commentary provided is the opinion of the author and should not be considered a personalised recommendation. The information contained within should not be a person's sole basis for making an investment decision. Please contact your financial professional before making an investment decision.

Securities Mentioned in Article
Security NamePriceChange (%)Morningstar
Rating
Clinigen Group PLC1,039.00 GBX-0.10-
Countrywide PLC116.75 GBX1.30-
Dechra Pharmaceuticals PLC2,083.00 GBX0.63-
FDM Group (Holdings) PLC954.00 GBX-1.50-
Fevertree Drinks PLC1,942.00 GBX0.83-
Foxtons Group PLC77.00 GBX0.00-
Renishaw PLC5,020.00 GBX-0.40-
About Author

Samuel Meakin  is a fund analyst for Morningstar