The future is small

Gervais Williams, Manager, Diverse Income Trust

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The recent years have been a tale of interest rates being held at record low levels, governments running sizeable budget deficits and the use of huge amounts of quantitative easing (QE). But rather than renewed world growth coming through, we’re all still in the departure lounge waiting for takeoff.

Some hope that the three arrows of Abe-nomics will reverse the trend.  Others point to the prospect of the European Central Bank commencing asset purchases. But even in the US where everything has been tried, in scale, low bond yields continue to foretell a story of slow growth.

For those with a meteorological bent, it’s easy to explain. On the windward side of a range of mountains, extra rain comes from clouds forced higher over the peaks. But beyond the watershed there’s little rain as the spent clouds descend.  It’s called a rain shadow.  The world seems to be entering a growth shadow. For the last two or three decades we have been borrowing growth from the future.  Now it’s payback time.

It’s a big challenge, as most asset classes appear to be a crowded trade. Yields on Government bonds, and even corporate bonds are meagre. Property yields don’t look much better, and most investors already have their fill of mainstream income equities. These questions are the focus of my new book, The Future is Small, - it explores the investment landscape in a world where growth remains sub-normal.

In this context, we’re incredibly lucky to have the Alternative Investment Market (AIM), one of the world’s most developed markets for genuinely small companies. It is a ray of light in a troubled world. Not because every year there are some tiny stocks that feature amongst the UK’s top stock market performers - but rather because smaller companies in general have more growth potential than larger businesses. That hasn’t been important during the boom when growth was plentiful. But with so many larger companies now running out of steam, it’s suddenly become horribly relevant.

So expect most UK investors to invest some 10 or 15% of their portfolios into small and microcap stocks going forward. It’s a radical thought. To many it seems inconceivable. But that’s where the best performance was in the past.  - during the two oil shocks in the 70’s and a decade when inflation averaged 13% per annum. - during a period when the UK was famed for its dysfunctional industrial relations and frequent recessions.  - during a time when equity markets were hugely volatile and unsettled.

Small and micro caps saw us through because some can grow even when the economy is flat. They outperformed because being quoted they had access to extra capital at a time when most private companies were capital constrained. And they attracted sustained institutional support because they were able to grow their dividends at time when many larger companies were trapped by their sales flat-lining. Small caps outperformed for decade after decade prior to the credit boom.

Even small additional increments of institutional allocations will now start to drive up the small cap market, because illiquidity can work both ways. As the smallest stocks outperform the commercial imperative to participate will become more urgent. Already many smaller company fund managers are expressing renewed interest in moving away from mid caps into rather smaller listed stocks. The wave will roll right down to the bottom of the market.  Because the smaller company effect is proportionate. In the past the best returns have come from the micro caps.

So this is not just a case of a period of small cap performance catch-up. It’s a structural change in the market trends. Expect a new super-cycle of AIM market returns over the coming decades.

Gervais Williams' new book The Future is Small: Why AIM will be the world’s best market beyond the credit boom was published by Harriman House on the 11th November.

Disclaimer

Past performance is not a guide to future returns. The value of investments and any income may fluctuate and investors may not get back the full amount invested. This fund may experience high volatility due to the composition of the portfolio. Investment in the securities of smaller and/or medium sized companies can involve greater risk than may be associated with investment in larger, more established companies.

The market for securities in smaller companies may be less liquid than securities in larger companies. This can mean that the Investment Manager may not always be able to buy and sell securities in smaller and/or medium size companies.

The views expressed are those of the fund manager at the time of writing and are subject to change without notice. They are not necessarily the views of Miton and do not constitute investment or tax planning advice. The mention of specific stocks must not be construed as a recommendation to deal. Whilst Miton has used all reasonable efforts to ensure the accuracy of the information contained in this communication, we cannot guarantee the reliability, completeness or accuracy of the content.

Miton is a trading name of Miton Asset Management Limited (FRN 115241) and Miton Trust Managers Limited (FRN 220241) incorporated and registered in England and Wales (with its registered office at 51 Moorgate, London EC2R 6BH) and authorised and regulated by the Financial Conduct Authority.