Selected Issue 6 - Summer 2019

PROVIDER SUPPORT – 17

Smaller Companies: not as risky as you think

Simon Evan-Cook, Senior Investment Manager for Premier’s multi-asset funds, explains smaller companies are never going to be risk-free, but still look a better long-term bet than buying a market-weighted tracker. We often conflate the vulnerability of one member of a species into the vulnerability of the species of a whole. An individual mosquito is weak and easy to kill, but as Bill Gates would attest, wiping out all mosquitoes is impossible. In fact, any efforts to do so only strengthens the species, as you kill the weakest individuals, leaving the strongest to refill the gene pool. The same principle applies to smaller companies. Individual members of those ‘species’ can go bankrupt at any time. But it’s usually the weakest that do so, leaving the stronger ones to pick up their customers, and to learn from the mistakes that derailed the failures. This is one of the reasons why we like small-cap funds. They allow us to access the strength of the ‘species’, while removing the existential risk that threatens each and every individual smaller company. Naturally, like anything, there are good and bad examples of small-cap funds, which is why we only invest with the very best. They should avoid most of the companies that go bust, leaving us with more of those that will survive and prosper. Sure, they won’t get them all right, but they only need to get more right than wrong to outperform their peer group (which itself has wiped the floor with its all- cap equivalent). Given this track record, why do people (us included) bother with large-cap funds at all? There are several answers to this, some good, some not so good. Most are linked to that widespread perception of small caps being riskier than their larger peers. This means that, in times of stress, investors are more likely to abandon their small-cap holdings, leading

to sharper drawdowns. This is why we use small-cap funds as part of a portfolio, not all of it: volatility is not the same thing as risk, but there will be times when the journey will be rougher than most investors can stomach. So putting everything into small-caps runs the risk of frightening investors into selling their holdings after a pull-back, which is usually the worst possible timing. There will also be times when small-caps as a whole become too expensive, and it will make sense to pare back. These are rare, and usually happen after a very good run for small caps, when greed is in the ascendancy, and investors’ collective tolerance for risk is high. This is another factor that makes small-cap investing psychologically tricky: Those are the only times when it feels comfortable buying small caps, but they’re also likely to be the times when you probably shouldn’t. Conversely, when it feels uncomfortable to own them, which is about 95% of recorded history, you probably should. They’re never going to be risk-free, but still look a better long-term bet than buying a market-weighted tracker. Find out more Contact Simon Morris, Head of Strategic Partners, on 07738 958 072 or email simonmorris@premierfunds.co.uk.

Simon Evan-Cook Senior Investment Manager at Premier Asset Management

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