Small can be beautiful

Small can be beautiful. That’s the message to financial advisers and wealth managers who are automatically excluding smaller investment companies from the lists of funds they consider for clients. For while there may be certain practical issues to confront for some intermediaries investing in these closed-ended funds, they also offer potential benefits.

Sarah Godfrey, an investment company analyst at Edison, made exactly this point in a recent article for Fund Strategy magazine. “By focusing only on those trusts that are large and ultra-liquid, advisers may be missing out on opportunities in potentially rewarding niches,” she warned.

The argument concerns those financial advisers and wealth managers who automatically exclude investment companies below a certain size – a market capitalisation of £200m is typical – from their buy lists. These firms, which increasingly deal on behalf of significant numbers of investors, worry that only a relatively limited number of shares typically trade each day in smaller trusts; they fear being unable to place the trades they want without moving the price unfavourably.

Another issue highlighted by some advisers is cost. All investment funds face certain fixed costs, which weigh disproportionately on those with fewer assets under management. This may mean investors in the smallest funds end up paying higher fees, advisers often warn.

It would be churlish to simply dismiss these concerns, which do have some merit. Equally, however, simply excluding all funds below a certain size from a buy list feels like throwing the baby out with the bathwater.

It may well be the case that a small investment company isn’t the right option for a wealth manager placing a trade on behalf of a sizeable number of its clients. But for smaller numbers of investors, or for portfolios managed on a discretionary and bespoke basis, liquidity issues may not present a headache. And in any case, it should be possible to overcome liquidity problems by working more closely with brokers, rather than depending on block trades.

Similarly, on the issue of charges, an analysis by Edison of 20 funds with market capitalisations of between £20m and £200m, and with five-year track records, found that more than half have ongoing charges of 1.5 per cent a year or less. That is relatively competitive compared to larger investment companies – or the open-ended fund sector.

What is the positive case for investing in these smaller funds? Well, they broadly divide into three categories: funds specialising in investment in a single country, funds specialising in UK smaller companies, and a number of smaller global funds.

Many offer a distinctive investment strategy that it would be difficult or impossible to replicate elsewhere. Aberdeen New Thai, for example, is the only retail fund that offers a specialist investment exposure to Thailand. Oryx International Growth focuses on absolute returns from small and medium-sized companies. Strategic Equity Capital is a smaller companies specialist known for its corporate engagement.

Sarah Godfrey also points out this fund universe can be an attractive place to go hunting for income. While the average dividend yield of the 20 funds identified by Edison is only 2 per cent or so, several offer 4 per cent or more, including Chelverton Small Companies Dividend, Shires Income and Acorn Income.

None of which is to suggest that any of these funds is suitable for all (or indeed any) of an adviser’s clients. Equally, however, dismissing smaller investment companies out of hand feels like a generalised approach to investment that it likely to result in value foregone.