"We Need to Hit Ctrl Alt Delete on the Global Economy"

VIDEO: It's been a tough year for small-caps, says Henderson Smaller Companies' Neil Hermon, but their long-term performance speaks for itself 

Holly Black 6 August, 2020 | 11:10AM
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Holly Black: Welcome to Morningstar. I'm Holly Black. With me is Neil Hermon. He is Manager of the Henderson Smaller Companies Trust. Hello.

Neil Hermon: Hi, Holly.

Black: So, smaller companies quite a tricky area at the moment. How have they held up so far this year?

Hermon: Clearly a very tricky year, a difficult year for equity markets in general and particularly for smaller companies for obvious reasons. Smaller companies have lagged larger companies year-to-date. The Numis benchmark index, which is a good proxy, is down about 24%, the small cap index is down 22%, whereas the FTSE 100 is down about 18%. So, not surprising typically in periods that have economic dislocation and difficult conditions, there's a flight to liquidity and safety of the FTSE 100. So, small companies have lagged a bit this year.

Black: So, are there areas of winners and losers within that though? It can't all be terrible.

Hermon: No, not at all. No. I mean, Covid-19 has clearly been a massive impact on the global economy, an unprecedented demand shock which we've never seen before clearly. Somehow, we have to press the Ctrl+Alt+Delete button on the global economy and start it again. So, essentially, we've seen massive structural change condensed into a very short period of time. Where it normally takes years to happen has occurred in a space of few months. Therefore, there have been some very clear winners as well as some clear losers from this crisis. In the winners camp you'd put those companies that shifted online – an increase on shift to online. So, companies like AO World, the electronic retailer; technologies providers facilitating the work from home environment. So, Computer Center and Softcat. Stay at home winners like computer game, software companies and home delivery like Domino's Pizza as well as more defensive names where demand has remained resilient, so companies like Dechra Pharmaceuticals, animal pharmaceuticals or defense companies.

Black: So, one thing that's been a bit of a headwind for the smaller companies over the last few years is Brexit. It feels like no one is talking about this this year because of the COVID-19 crisis. Is Brexit something that's still on your mind?

Hermon: Yes, it is actually. I mean, the speed and severity of credit crisis really has pushed Brexit off the agenda to some extent. It's still there though. And obviously, at some point they will kind of negotiate a trade deal with the EU. We've got the end of the year before we exit and the hard Brexit. Talks seem to be going not that well at this point in time and clearly, trying to negotiate a complex trade deal over Zoom is a bit difficult. But there's still time to be honest actually in terms to get things sorted out. But it's certainly something which is not front and center for the equity market but will increasingly come into focus as we go through the next few months. But even with some of that it's not the only concern and risk out there. We talk about Covid, Brexit, but also, you've got kind of worsening Sino-American relationships, potentially trade war and a U.S. election in November. So, lots of things for the equity market to worry about at the moment.

Black: So, Neil, with all of those worries why should I consider investing in smaller companies?

Hermon: Look, I think, this year has been a tough year for small caps for not unsurprising reasons as we mentioned earlier. However, the long-term track record of small companies is fantastic. If you put £1,000 into the Numis Index back in 1955, it'd now be worth £757,000. A similar investment in the FTSE All Share would now be worth £118,000. So, with that very long term 65-year periods small caps have done 6 times better than large caps which is an average outperformance of 3.2% per year every year for the last 65 years. The reasons for that performance I don't think have really changed. I mean, essentially you think about smaller companies, its entrepreneurial management teams, its more operational leverage, the law of large and small numbers growing from a smaller base, the source of new technology and services, all those things remain valid. So, ultimately, I think from a medium to longer-term perspective, smaller companies can provide excellent returns for investors. Short term, more opaque; but long term, still very confident.

Black: Neil, thank you so much for your time. For Morningstar, I'm Holly Black.

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.

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Holly Black  is Senior Editor, Morningstar.co.uk