Good Things Come in These Small (Fund) Packages

Smaller funds have an advantage over their larger counterparts when it comes to changing course

Adam Zoll 11 April, 2012 | 2:40PM Alanna Petroff
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Sometimes in investing, size does matter, but that doesn't mean bigger is always better. In fact, sometimes the Davids have advantages over the Goliaths.

For example, let's say the manager of a £10 billion fund wants to reposition his or her portfolio, adding a greater allocation to foreign stocks. Each 1% shift in allocation represents a £100 million shift in assets into whatever foreign companies the fund manager finds attractive. Such a large move into a handful of stocks is likely to make waves in the companies' stock prices, potentially making the shares more expensive in the process. Now multiply that effect by 5 or 10 times to represent a substantial shift in the fund's foreign-stock allocation, and you'll start to understand why the biggest funds, like the biggest ships, take great effort and planning to chart a new course.

Now contrast that with a smaller, more nimble fund undergoing a similar repositioning exercise. Its £500 million (or less) asset base requires just £5 million to shift its portfolio 1%. That might be barely enough to make a ripple in the trading price of a company it wants to add to its portfolio. Think of this smaller fund as more like a small boat, skimming along the surface, able to turn on a dime while watching the big boats lumber along. The small fund's advantages are even more pronounced when investing in small- and mid-cap stocks, where a large fund's giant asset base can make the biggest waves.

When a storm hits--in the form of an unforeseen natural disaster or other type of market shock--the small boat (smaller fund) will have a much easier time steering to safer waters--for example, moving assets into less volatile stocks--while the tanker ship (larger fund) has a much tougher time. Likewise, in a market upswing the small fund has the ability to take advantage of changing conditions much more rapidly than its larger counterpart.

Using Morningstar's Fund Screener, you can search for small, Gold-rated funds with asset bases of no more than £500 million. We ran this search using the Fund Screener by looking for funds with the following characteristics:

- UK Open End Funds
- Denominated in pound sterling (GBP)
- Excluding funds of funds
- Non-institutional funds only (which means these funds are specifically for individual investors instead of institutions and banks)
- Gold-rated funds
- Less than £500 million in assets

We found a small selection of interesting funds that you may want to consider if you're looking for nimble, niche open-end funds. Most of them are small-cap focused and some of the funds listed below have experienced 10%+ returns so far this year.

Aberforth UK Small Companies
This Gold-rated fund focuses on investing in small UK companies that have been undervalued by the market. Currently, it's year-to-date return has exceeded 15%.

Old Mutual UK Smaller Select Companies
This Gold-rated fund is considered to be a "strong offering within the competitive small-cap category," according to Morningstar analysts. The fund has been managed by Daniel Nickols since 2004. According to Morningstar's latest research report: "We believe the fund benefits from the manager’s pragmatic and flexible investment approach with no particular bias toward value or growth." So far this year, the fund has returned more than 10%.

Artemis UK Smaller Companies
According to Morningstar OBSR analyst Chetan Modi in his latest research report, this Gold-rated fund is of very high quality. "The fund boasts an experienced manager who benefits from being part of a talented UK equity team," says Modi. However, the fund often invests in micro-cap companies, which could amplify losses when markets take a dive because of liquidity constraints amongst micro-cap firms.

Allianz RCM Europe Small Cap Equity
This Gold-rated fund focuses on small and mid-cap companies across Europe and the UK. Currently, 50% of assets are invested in eurozone companies and 21% of assets are invested in UK companies.

GAM UK Diversified
This Gold-rated fund has been managed since its inception in 1990 by fund manager Andrew Green. It focuses on investing in mid-cap companies and specifically searches for value opportunities. Most of its investments are in UK companies.

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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About Author

Adam Zoll  is an assistant site editor with Morningstar.com, the sister site of Morningstar.co.uk.