It’s fair to say 2022 was tough for funds investing in smaller companies, with many ending the year nursing substantial losses. They were hit by a combination of stock market volatility, a lack of enthusiasm for growth companies, and an ongoing cost of living crisis.
But could 2023 be the year that small caps around the world outperform – and which regions are likely to deliver the best returns in such a scenario?
Here we look at the pros and cons of investing in these firms, as well as highlighting five interesting funds in this area that are worth considering.
Smaller companies are often innovative businesses in the exciting growth stage of their development. This gives investors the opportunity to ride the wave of their success. Just imagine buying the next Apple or Microsoft and seeing the value of your holding in the stock soar as the firm starts taking over its niche.
There is also more chance of smaller companies delivering better-than-expected returns as they are followed by fewer stock market analysts. Of course, there are also downsides. Smaller companies are often unproven so the chances of them failing or running into financial problems is greater. After all, not every great idea turns into a great business.
The past year hasn’t been great for investors in smaller companies, with the average returns of all sectors covering such firms mired in negative territory. The IA US Smaller Companies was the biggest disappointment, losing 10.58% in 2022, according to data compiled by FE fundinfo*.
The IA Japanese Smaller Companies sector was next with a 9.79% loss, followed by IA European Smaller Companies, which ended the year down 9.21%*.
The best performer covering this area was IA UK Smaller Companies, although even this sector lost 7.68% over the course of the year*.
Here, we spotlight five funds covering different parts of the small company universe.
Let’s start with companies close to home. The TM Tellworth UK Smaller Companies fund aims to provide long-term capital growth. The portfolio is managed by the trio of Paul Marriage, John Warren and James Gerlis.
In their most recent update, the managers acknowledged the problems of the past year but insisted there were signs of optimism. “There are good reasons to think that 2022 may prove to have been the trough for small caps, not least as valuations for many stocks are priced for much worse news than hot wars in Europe, inflation and higher rates,” they wrote.
The fund, which was launched in November 2018, is well diversified and doesn’t have either a style or sector bias. Currently, its largest holding – of 4.2% – is in Gresham Technologies, a software and services business that provides real-time transaction control and regulatory reporting solutions**.
Europe is home to many leading global names and one way to access these potential gems is through the Janus Henderson European Smaller Companies fund.
Writing in their quarter four update, managers, Ollie Beckett and Rory Stokes gave a relatively upbeat assessment of the outlook for European equity markets. “We think equities should be in a better place by the end of 2023 as easing interest rates could open
the door to a degree of normalisation in terms of share price valuations,” they wrote.
Their portfolio, which was launched in January 1985, currently has 92 holdings***. The largest position is the 3% it has in IPSOS, the Paris-based multinational market research firm***. BFF Bank, the Italian finance business, is next with a 2.47% share of assets under management, followed by the 2.15% in Kindred Group, the Malta-based online gambling operator***.
The outlook is challenging in the US, with many people expecting a recession as the US Federal Reserve continues to raise interest rates. However, there are still ways to potentially make money, according to Cormac Weldon, the experienced manager of the Artemis US Smaller Companies fund.
“In an environment like today’s, there are several ways investors can mitigate the impacts of a possible – many say probable – recession in 2023,” he wrote in an update. These include buying non-cyclical stocks, putting money into infrastructure, and looking to benefit from the transition to net-zero in the US.
“Perhaps a more opportunistic approach to portfolio management in times like this is to trawl through the beaten-up stocks for bargains,” he added. “We agree there will probably be a slowdown in 2023.”
Then there are Japanese smaller companies. The Baillie Gifford Japanese Smaller Companies fund is run by Praveen Kumar, who looks specifically for innovative names that have the potential to be future industry leaders.
He invests in attractively valued smaller companies, while growth may come from innovative business models, disrupting traditional Japanese practices, or general market opportunities.
According to the most recent factsheet, the 10 largest holdings in the fund currently account for just over a quarter of total assets under management***. TechnoPro, a technology-focused staffing and service business is the pargets holding at 3.5% of asset under management***.
As far as sectors are concerned, the industrials sector currently accounts for 31% of assets, followed by 18.8% in information technology and 15.5% in consumer discretionary names***.
If you would prefer a mix of smaller businesses from a variety of countries, then it may be worth considering the abrdn global smaller companies fund. This fund identifies companies from across the globe – including the emerging markets – that are believed to have the best growth prospects.
Fund manager Kirsty Desson and her team focus on maintaining a diverse asset mix at the country, sector, and stock level. The aim is to find stocks that display high quality characteristics, operate in growing markets, and display positive business momentum.
According to the most recent factsheet, the US has the largest country allocation of 43.4%, followed by the 6.8% in Australian names and the 6.5% in Japanese companies***. However, it also has exposure to Taiwan, Italy, Germany, the UK, and France**. Information technology, meanwhile, is the favoured sector, followed by industrials***.
*Source: FE fundinfo, total returns in sterling, 31 December 2021 to 31 December 2022
**Source: fund factsheet, 30 December 2022
***Source: fund factsheet, 30 November 2022
Past performance is not a reliable guide to future returns. You may not get back the amount originally invested, and tax rules can change over time. The views expressed are those of the author and do not constitute financial advice.