After a period of nearly five years underperformance relative to the S&P 500, small-caps rated on th...
After a period of nearly five years underperformance relative to the S&P 500, small-caps rated on the Russell 2000 index began outperforming at the end of last year.
Since the start of this year, the total return earned on the Russell has dropped by 8.42% in dollar terms. While negative, this was an outperformance of 9.56% over the S&P 500, which returned -13.67%.
The picture is rosier if analysed over five years. Since the end of June 1997, the Russell 2000 index has risen 25%, some 5.28% more than the S&P 500 at 19.72%. The Russell overtook the S&P in November last year and has maintained its lead ever since, although both indices have dropped nearly 10 points since the beginning of April 2002.
Andrew Dove, manager of the American Smaller Companies fund at Aegon, believes the major issues facing US small caps are dollar weakness and the accountancy scandals currently rocking the corporate world.
'Dollar weakness has wider importance for small US companies as they don't do as much overseas business as the larger US stocks,' he says.
'Larger companies tend to do well during periods of dollar weakness because their exports are more competitive.'
While the fraud scandals affecting companies such as WorldCom and Enron are not a good thing for the market in general, they do not impinge directly on the small-cap sector, Dove says, as they tend to have simpler accounting procedures.
Not so, says Zanny Perring, manager for Threadneedle's North American Smaller Companies fund. 'People have been thinking that, because smaller companies are smaller, they are not prone to accounting irregularities,' she notes.
Fraud has already been unearthed in the small-cap sector, she adds, pointing to HPLA, a software company in the semiconductor sector.
'The CEO looked to have fabricated 80% of the company returns,' Perring points out.
Dove does not discount the possibility of one or two firms among the thousands of small-cap US companies indulging in accountancy fraud. But, he says: 'People feel more comfortable in the small-cap sector.'
In a volatile market, investors usually go to the large-cap sector but, Dove says, this is not happening because of a fear in the market that further scandals will be uncovered.
A secondary consequence of the scandals, Perring says, is that banks will be much more stringent in their lending, which will make it harder for the small-cap sector to obtain borrowing. This will, in turn, disadvantage small-caps against the large-cap sector.
'We are in a rotational bear market at present so I'm downgrading the holdings that have held up,' she says.
One such stock is Northfolk Bank, which has been the largest holding in the Threadneedle Smaller Companies fund for the past five years. Perring recently sold 20% of the stock simply because it has held up well so far and she felt the time had come to lock-in profits.
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