There are two indices against which institutions offering funds that invest in small companies measu...
There are two indices against which institutions offering funds that invest in small companies measure their performance. The Hoare Govett Smaller Companies Index was established in 1987 to measure the performance of the lowest capitalisation stocks that together represent one-tenth of the value of all listed UK equities.
At its launch, the market capitalisation cut-off point was £108m. Subsequent rebalancing brought it to £298m at the beginning of 1993. At that point, the FT Smaller Companies Index was launched, including companies with a market capitalisation of up to £300m.
Changes have taken place in the shape of the UK equity market. The market capitalisations of larger companies have swelled as building societies have demutualised, listing as large companies in their own right. Several large mergers have taken place, including the BP/Amoco deal which created a company with a market cap of twice the FT's smaller company index.
The rebalancing of the Hoare Govett Index at the start of each year has helped reflect this change. Its market cap limit for smaller companies has doubled since 1996 to £585m at the start of 1999. By contrast, the FT universe of smaller companies has been diluted since it comprises only those companies that are not constituents of the larger FTSE 350 Index. Its share of the total market has shrunk from 8% to 4% and it includes just over 460 companies, while the Hoare Govett universe comprises around 1,600 companies.
Using the FT SmallCap Index as a benchmark, investment managers were reduced to investing in a smaller pool, calling into question the economic viability of employing teams of analysts. A trend is developing towards redefining small cap companies as those with a more meaningful market cap of up to, say £1bn.
The FT SmallCap Index has thus become a marginal benchmark. We expect more investors will embrace this wider definition of smaller companies. This will enable investment in companies with greater growth potential than many of those at the lower end of the range. Investors will undoubtedly benefit since such companies are likely to expand more rapidly and to produce higher returns on equity by financing their development more efficiently and aggressively.
Institutional investors in particular will focus on the broader range of companies which constitute the lower reaches of the FTSE 350 Index and the upper end of the Hoare Govett Index. Companies at the lower end of the range, comprising a good part of the FT SmallCap Index, will become less institutionally owned, relying increasingly on private investors. If trends persist, we expect a complete reorganisation of the FTSE Index series. In the meantime, it seems the FT SmallCap Index will become increasingly unviable.
Gervais Williams is senior investment manager at Gartmore Investment Management
Putting the tech into protection
Square Mile’s series of informal interviews
Fallout from Haywood suspension
Launching later in 2019
£80bn funds under calculation