By Robert Stock Only two of the 77 funds in the UK Smaller Companies sector returned positive growth...
By Robert Stock
Only two of the 77 funds in the UK Smaller Companies sector returned positive growth in the three months prior to 24 May, according to Standard & Poor's.
These dramatic reversals, and the spectacular gains that came before them, have brought about unprecedented levels of volat-ility in the sector, beaten only by the Far East, emerging markets and commodity and energy sectors.
While in February only one UK Smaller Companies fund had negative three-month performance but not all of the gains achieved have been given back.
The average return on a bid to bid basis for a fund in the sector in the three months up to 24 May 2000 is -18.1% compared to average offer to bid returns of 55.5% over 12 months, and 87.1% over three years.
In February the three year figures stood at 34.8% and 68% respectively.
Volatility in the sector measured by Standard & Poor's has shown sharp increases, most significantly in the first quarter of 2000.
In March 1999 the average fund volatility score, measured the standard deviation of 36 monthly total returns on an offer to offer basis for the UK Smaller Companies sector was 4.5, which increased to 4.6 by November 1999. By the end of February 2000 it had grown to 5.8 and reached 6.0 by the end of April. By the end of May 2000 it stood at 6.5.
Within the sector 16 funds now have a volatility score of 7.0 or more, six have ratings over 10, and two have ratings over 11. The highest rating of 11.7 is Duncan Lawrie Smaller Companies, and only three companies have ratings equal to or below the March 1999 average.
A year ago the most volatile fund, the Dresdner RCM Smaller Companies, had a volatility rating of 5.7 while only seven other funds topped 5.0.
Despite the setbacks, the majority of fund managers in the UK smaller companies sector, like their large cap counterparts, still see technology as the only credible area offering high trend growth prospects.
During the tech, media and telecoms correction, many cut back their positions to protect their gains but are now moving to take advantage of more reasonable looking valuations to overweight technology again. This repositioning is based on widespread expectation that the tech, media and telecoms sectors will outperform in the later stages of 2000 and early 2001.
Paul Cramp, manager of Threadneedle UK Smaller Companies Growth fund, which has fallen to 51 in the sector with negative three month returns of 21.1%, said it will not be until the fourth quarter of this year that technology picks up, although the run will carry through into the first quarter of 2001.
Cramp is currently overweight in the IT services sector, and slightly overweight in technology, having been double weighted until mid-March.
He said: "We tilted away from our heavily overweight position in technology earlier in the year through March and the beginning of April.
"I think the next shift that will happen is that we will probably begin to push our tech higher again over the next quarter or so provided we can find the right quality companies.
"The prices are now much more attractive. We will probably do that at the expense of some of the companies within industrials."
Andy Crossley, head of the team that manages the INVESCO GT UK Smaller Companies fund, which is ranked 57 with negative three month returns of -22.4%, sees strong growth potential in UK smaller company tech, media and telecoms stocks.
Crossley said much of the froth has been blown out of the market, and these stocks are beginning to look exciting again. He had held double weighting in technology until the correction in March and April.
However, Crossley said at the moment there is an ongoing return to traditional bottom-up stock-picking, which used to be the mainstay of the sector as a whole.
Crossley said, that due to a buoyant UK economy, smaller companies are predicted to grow their earnings by around 14%, far above the 8% earnings growth of their large cap rivals.
Many of the companies that will benefit, like house builders and private client stockbrokers, are currently trading at large discounts. However, there is no trend to play that comes close to matching the tech, media and growth.
The Capel Cure Sharp UK Smaller Companies Fund has fallen to 70 in the rankings with negative returns of 29.1%. Its manager Simon Smith said: "The stocks which have really led the funds higher and higher for the last two to three years are the ones that have come off since March. So it is the funds that have performed well in that time cycle, that have mostly been performing badly over the last three to four months."
Smith, whose portfolio has a 40% technology sector weighting, said: "We have seen major falls over the last three months which have been disappointing but we have stayed clear of the dot.coms and the more speculative technology stocks.
"We have taken some money out of the tech area and have repositioned that back into manufacturing where we see some cyclical upturn and have been very generally picking up stocks which will see earnings growth. But we are starting to look at buying tech again."
He acknowledged the momentum story but said that from now on investors will be more selective in their pursuit of tech, media and telecoms.
He said: "We have seen an indiscriminate rise and then an indiscriminate fall, and now the market will decipher which are the good stocks and which are the bad businesses. When the market starts to level out, which it is doing now, it is our stocks that will do well."
The interruption of the tech story has value managers breathing a sigh of relief. The two UK smaller company funds which produced positive performance in the last three months are both value-oriented funds with significantly lower r
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