Elephants don’t gallop

Smaller companies can deliver surprisingly big returns to investors seeking growth or income. The City saying “elephants don’t gallop” suggests why some investors prefer nimble, smaller businesses with the potential for rapid growth in capital values and/or dividends.

Unfortunately, higher rewards usually entail higher risks. Smaller companies are unlikely to have large contingency reserves to cope with unexpected setbacks and are more likely to rely on a single trade, instead of a range of unrelated activities.

So investment companies’ tried and tested ability to diminish risk by diversification – or spreading individual shareholders’ money over dozens of different businesses – is especially important in this sector. Sharing the cost of professional stock selection is also particularly valuable because, almost by definition, smaller companies are unlikely to be ‘household names’, scrutinised by large numbers of institutional analysts.

That’s why I hold six investment companies in my ‘forever fund’, which give me exposure to a wide variety of medium and smaller businesses around the world. They are Baillie Gifford Shin Nippon (stock market ticker: BGS), European Assets Trust (EAT), India Capital Growth (IGC), JPMorgan US Smaller Companies (JUSC), Schroders Capital Global Innovation (INOV) and VinaCapital Vietnam Opportunity Fund (VOF).

So far as I can see, these investment companies deliver ‘uncorrelated returns’ – or, in plain English, their share prices don’t all go up or down at the same time. That suits this long-term investor just fine because I would rather avoid extreme fluctuations between feast and famine, where an unbalanced downswing might prompt panic decisions, such as selling at the bottom.

On a more positive note, India Capital Growth (IGC) shows how medium and smaller companies can reward shareholders. To be candid, I had never heard of its top ten holdings – which include the pipes and poles-maker, Skipper, the healthcare company, Emami, and the metal works foundry, Ramkrishna Forgings.

But I am glad this investment company gives me exposure to these opportunities because IGC has delivered total returns of 31% over the last year. That’s over six times more than the average investment company return of 4.8% over the same period, according to independent statisticians Morningstar.

IGC’s returns over the last five and ten-year periods, of 84% and 433% respectively, also beat the average investment company returns of 70% and 155%. Even so, IGC shares continue to be priced 8.4% below their net asset value (NAV), possibly because they pay no dividend income.

That omission is addressed in my smaller companies portfolio by European Assets Trust (EAT), which currently yields 7% and delivered total returns of 12% over the last year. However, it is only fair to say EAT’s five and ten-year performance has been disappointing, with returns of 2.8% and 75% respectively.

With JPMorgan US Smaller Companies (JUSC), it has been the other way around, with long-term returns proving more satisfactory than recent performance. I have been a shareholder in JUSC for more than a decade, where total returns have fluctuated between minus 1.7% over the last year, a positive 7.2% over five years and another positive 150% over the decade.

The Japanese smaller companies specialist, Baillie Gifford Shin Nippon (BGS), is another investment company I have held for more than a decade. During that period, the manager’s focus on businesses that pay no dividends but might deliver capital growth has fallen from favour.

This is reflected in BGS posting negative returns of minus 17% and minus 38% over the last year and five-year periods. Over the last decade it remains 103% up and I intend to remain a shareholder in the hope that its investment style might return to favour in future.

That raises the important point that smaller companies are not immune from changes in financial fashion or fluctuating interest rates. Recent examples include the rotation into value shares – or those that pay decent dividends – since interest rates began to rise after the Covid crisis. Future money costs are unknowable but I expect a diversified portfolio to create winners as well as losers from whatever happens.

Just as a racing boat can turn more tightly than a container ship, some smaller companies may recover from setbacks quickly. According to Kepler Trust Intelligence analysis stretching back to 1955, every time UK smaller companies have had a negative calendar year, they delivered positive returns within three years.

Extreme downturns can precede extreme recoveries, such as that seen after the global financial crisis 15 years ago. Investors in the average UK Smaller Companies trust in September 2008, received a total return of 39% three years later and 134% after five years. Of course, not every acorn will grow into an oak but investment companies focussed on smaller businesses can continue to reward medium to long-term investors.

All performance data correct at 4 October 2023.