Why smaller is better

Equities look like they could increasingly be a good place to invest. Smaller companies tend to do better than large ones.

The big news today is the UK Autumn Statement.

This is in effect a second Budget, as I wrote about last week. It’s very important to both your personal finances. It could also affect your savings and investment portfolio. So we’ll be closely watching the words and the promises of the new Chancellor of the Exchequer. But rather than come up with some snap views now, we’ll give you our considered opinions on his Autumn Statement later.

Today I’d like to talk about another leading light in the financial world.

Yesterday it was announced that Professor Elroy Dimson is to join the team that manages the investments of Gonville & Caius, the fourth-oldest Cambridge college.

So what, you may ask. And who’s Prof Dimson anyway?

Well, he’s been described as the world’s foremost authority on the history of financial markets and a leading practitioner in endowment investing.

From 2007-16 he was a Council Member of the Norwegian Government Pension Fund Global, one of the largest sovereign wealth funds in the world. Over the same timeframe he’s also been sitting on the Investments Committees of Guy’s & St Thomas’ Charity and UnLtd (the Foundation for Social Entrepreneurs).

A co-designer of the FTSE 100 index, he chairs the Academic and Policy Boards for FTSE Russell and the Newton Centre for Endowment Asset Management at Cambridge Judge Business School. He’s Emeritus Professor of Finance at LBS. And he’s co-authored a book called “Triumph of the Optimists”, a pioneering long-term study of market returns in 23 countries from 1900 to the present day.

In other words, he’s got serious street cred when it comes to financial markets. He really knows what he’s about.

But there’s one aspect of Professor Dimson’s research that is particularly interesting to us at Agora Financial.

Along with his London Business School colleague Paul Marsh, Prof. Dimson publishes the Numis Smaller Companies Index. This measure excluding investment companies, known as NSCI XIC for short, has become the definitive benchmark for monitoring the performance of smaller-and mid-sized companies in the UK.

And every year the two Profs release a report on how smaller companies are faring.

The figures are quite spectacular. Over the four years to end-2015, the NSCI XIC stacked up an annualised return of 17.9%, more than double the FTSE All-Share return of 8.5%.

Look further back and the stats are equally stunning. Since 1955, the NSCI XIC has achieved a 15.4% compound return, 3.6% per annum above the FTSE All-Share. Indeed, during the period between 2000 and 2015, smaller companies outperformed larger ones in 90% of worldwide markets. If global equities are rising, you should have your money in stocks at the lower end of the market cap scale.

Back to today. Market sentiment is changing as a result of the US Presidential Election result.

Bonds – which generally pay a fixed rate of interest – have been in a bull market for some 30 years as market yields have fallen. Bond prices have climbed as a result.

Yet investors in US bonds are having a re-think. They’re starting to take a less wary view of the future of the America’s economy. Because this drives global economic activity, they’re wondering if the world is going to be jolted out of the low-growth, low-inflation and low-interest-rate rut in which it’s been for the last few years.

For stock markets, this could be very important. Higher inflation is bad for fixed-interest instruments such as bonds. That’s because the income stream that they pay becomes less valuable in real, i.e. inflation-adjusted, terms.

But stock market investors aren’t as fussed about inflation. If consumer prices rise, corporate earnings will go up too. Shares are a good inflation hedge. This implies that if money starts pouring out of government bonds, it’ll be looking for homes that generate higher returns.

An obvious target will be equities, in particular shares in smaller companies. We’ve noted their superior return potential above. What’s more, it will only take relatively small amounts of cash to drive many smaller caps much higher.

What does this mean for your portfolio?

I’ve been trying to unearth an expression to describe the opposite of the “Perfect Storm”, i.e. when everything comes right. In truth, I’m having trouble finding anything good enough. But this is what we now have here.

Equities, not bonds, look like they could increasingly be a good place to invest. If shares do well, smaller companies have shown that they do better than large ones. And Agora has a specific newsletter that focuses on small cap stocks.

At The Penny Share Letter, editor Sean Keyes is very clear in his mission. It’s to help you find stocks that could double, triple or even go up ten times in value. And he employs a methodology that focuses on the best-quality small caps around.

OK, you may not be able to invest in Prof. Dimson’s fund at Gonville & Caius College in Cambridge. But you can find out more about Sean’s ideas in The Penny Share Letter by clicking here.

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