Fund manager's comment/Alan Miller Since the beginning of the year a strange phenomenon has been tak...
Fund manager's comment/Alan Miller
Since the beginning of the year a strange phenomenon has been taking place. The FTSE 100 Index, which rose by 17.46% last year, has begun to stumble as investors have started to take notice of the turnaround in the small- and mid-cap sectors.
Last year the only investment principle that seemed to matter was the size and valuation of a company. The larger the size the safer the investment was perceived to be. Many institutions and fund managers appeared to give up on smaller companies as the sector had underperformed its larger index for five years. As a result, the top 15 stocks in the FTSE All-Share represented nearly 45% of the index as opposed to 30% in 1994.
Some active managers responded to this by indexing their portfolios to these top companies. Various high-profile leading smaller company investors predicted the terminal demise of smaller companies. They cited reasons ranging from the need to be larger in a European context to the lack of exposure to the global sectors of telecoms, banks, pharmaceuticals and oils.
Meanwhile, their broking counterparts took a similarly gloomy view of smaller company prospects. This depressive fatalism obviously took place late in 1998 when small companies had suffered one of their worst performances on record.
While the jury was still out during the first quarter of this year, falling interest rates and a more buoyant than expected economy have enhanced the continued prospects of recovery for the Small Cap Index. Indeed, it has risen by 33.6% this year compared with the FTSE All-Share rise of 16.08% and the FTSE 100 Index rise of 13.04%.
The reason for the turnaround is easy to understand. Smaller companies have been cheap in comparison with their larger counterparts for some time. The question we continually discuss is: "Why should we pay such a high rate for companies such as Vodafone when you can invest in alternatives at a P/E of nine to 10 times earnings, which are growing at a higher rate?"
This contrarian view has been taken on board by the experts in the small cap arena - venture capitalists, rival companies and company directors. The level of takeover activity occurring in this sector this year has not been apparent for several years.
Similarly, evidence of company directors buying shares in their own companies is no better illustrated than within the small cap sector, where the buy-to-sell ratio is considerably higher here than for large companies.
The prospects for the coming six months also appear satisfactory, as fears of a UK recession have subsided. Inflation looks to be under control and there is also scope for further interest rate cuts. As the year progresses, the recent trends in the UK should continue if the economic and political news remains positive.
Over 40% of the fund is now invested in small companies as we expect the fund to continue to benefit from those opportunities. We are however keenly awaiting the day when the same institutions and brokers, who became very bearish last October, decide to be upbeat.
Alan Miller is director and fund manager at Jupiter Asset Management
l High merger and takeover activity.
l High directors' buy-to-sell ratio.
l Valuations are looking attractive.
l Impact of any economic slowdown.
l Possible rise in interest rates.
l Trend for institutions towards indexation.
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