Are smaller companies a safe haven for investors?

Punters perplexed by the stock market’s recent gyrations should look for guidance in how the different indices have reacted over the past week or so. In nearly eight days, the FTSE 100 list of top companies is down around 6 per cent, while the Small Cap index has fallen by nearly 7 per cent. But the big falls have been in the FTSE 250 index of middling companies, off 9 per cent, and on the Alternative Investment Market, which has slumped by more than 10 per cent.

What this performance shows is that the shares that have flown highest this year, the mid-250 stocks and those on AIM, have been burned most. By contrast, the most sheltered areas of the market have been where this year’s laggards reside, amongst the very biggest and smallest companies on the main London market.

But are smaller companies such a haven? Several of the managers of small cap investment trusts were displaying their wares at a conference in the City organised by the stockbroker Arbuthnot today. All were agreed that there was still plenty of good value to be had amongst smaller fully-listed companies, while many thought that AIM too still has lots to offer.

Reading between the lines, however, it is clear that many small cap managers are becoming more cautious. For instance, it was pointed out that the valuation of the sector, measured as a multiple of expected earnings, now stands at a premium of around 20 per cent to that of the FTSE 100 index.

Ed Beal of Dunedin Smaller Companies Investment Trust argued that the difference could be justified by the fact that smaller company’s are expected to grow their earnings at 2.5 times the rate of their larger brethren. But, as both Roger Whiteoak of Throgmorton Trust and David Ross of Aberforth UK Smaller Companies Trust suggested, those higher ratings are vulnerable if company profits don’t come through as expected.

For now, the good news is continuing to flow for many companies in the sector. However, there was also something of a consensus amongst the managers that certain sectors were looking overblown for smaller companies, notably oil & gas, mining, property and general financial. They could be badly hit if, as one or two speakers suggested, the whole stock market continues to look sickly for the next several weeks or even months.

So, while the smaller company bandwagon may roll on, returns will almost certainly be down on the spectacular profits of the last few years. Investors who want to hedge their bets on the stock market may find the best way is by not straying too far from FTSE 100 index.