Interactive Investor

Ian Cowie: this trend has not always been my friend

Following new analysis showing that smaller companies outperformed larger companies in 2023, our columnist looks at how his five smaller company investment trusts have fared over both the short and long term.

18th January 2024 09:34

Ian Cowie from interactive investor

Home bias might hurt your investment returns, especially if you stick to household names. Smaller and medium-sized British businesses tend to, especially over longer time periods, deliver bigger returns than their larger domestic rivals but overseas corporate tiddlers do even better, according to new analysis by Deutsche Numis stockbrokers.

The authors of the report, Scott Evans and Paul Marsh of The London Business School, found that medium-sized or mid-cap UK companies returned an average of 13% last year, while the Deutsche Numis small-cap index delivered 10%. Both were well ahead of the 8% average achieved by the large-cap Deutsche Numis All-Share benchmark.

Meanwhile, during 2023 smaller companies around the world achieved an average total return of 16%, compared to 18% in America, 22% in Japan and an eye-stretching 44% in India.

While we can all fish for minnows in our home market - did I ever tell you about Fevertree Drinks (LSE:FEVR)? When it comes to overseas smaller companies few individual investors are likely to have any hands-on knowledge. Fortunately, investment trusts make it convenient and cost-effective to build diversified exposure to businesses which are not yet household names but might grow rapidly overseas.

Never mind the generalities, how did the theory turn into practice with my own shareholdings in smaller companies investment trusts scattered around the globe?

To be specific, I am talking about Baillie Gifford Shin Nippon Ord (LSE:BGS), European Assets Ord (LSE:EAT), India Capital Growth Ord (LSE:IGC), JPMorgan US Smaller Companies Ord (LSE:JUSC) and VinaCapital Vietnam Opp Fund Ord (LSE:VOF).

Let’s grasp the nettle and get the bad news on the record first. My Japanese smaller companies specialist BGS is the worst performer in its Association of Investment Companies (AIC) sector over the last year and five years with negative returns of -16% and -24% respectively, albeit with a more satisfactory positive return of plus 96% over the last decade, according to independent statisticians Morningstar.

Sad to say, the BGS focus on capital growth in future without any dividend income today has fallen from favour since rising interest rates made Mr Market lose his taste for jam tomorrow shares. Bigger businesses in the Land of the Rising Sun delivered higher returns than BGS over all three standard investment periods, suggesting that sector-based generalisations are no compensation for specific mistakes in stock selection.

My continental European smaller and medium-sized specialist EAT is not much better with total returns of minus 4.6%, followed by a positive 22% and 63% over the last year, five years and decade respectively. That leaves EAT at the bottom of its sector over the second and third of those periods, albeit with some compensation in the form of a 7% dividend yield.

Once again, I would have been better off with bigger companies on the continent, where the AIC Europe sector delivered higher average returns over all three standard periods.

Thank heavens for small companies and mid-caps in India where IGC achieved sparkling total returns of 35%, 97% and 380%. All three beat my more big business-focused fund on the subcontinent, JPMorgan Indian Ord (LSE:JII), which lagged behind with 13%, 35% and 173% over the same periods. Neither IGC nor JII pays any income.

Meanwhile, the biggest economy on earth proved a mixed blessing for smaller companies where JUSC delivered total returns of -0.4%, 41% and 147%. Once again, funds focused on bigger, blue-chip businesses in the AIC’s America  sector did better over all three periods and JUSC’s meagre 0.65% dividend yield offered cold comfort.

To end on a brighter note, substantial private equity and other unlisted assets helped VOF survive the last difficult year in Vietnam with a total return of -3.2%, following an altogether more satisfactory and positive 51% over five years and 274% over the last decade. That beats the more blue-chip focus of Vietnam Enterprise Ord (LSE:VEIL), which I switched out of to buy VOF, largely because VEIL pays no income, while VOF yields 2.4% that has risen by an impressive annual average of 15% over the last five years.

It is important to beware that dividends are not guaranteed and can be cut or cancelled without notice. Even so, if VOF could sustain its current rate of dividend increases, shareholders’ income would double in less than five years. That makes its current share price, which is 20% below its net asset value (NAV), look like a bargain for income-seekers who are willing to accept the bigger risks entailed in smaller companies, especially those trading in emerging markets. For comparison, the discounts to NAV at BGS, EAT, IGC and JUSC are 12%, 9%, 6% and 10%.

Returning to where we began and the Deutsche Numis Indices 2024 Annual Review, my personal experience as a shareholder in various investment trusts suggests some specific exceptions to the brokers’ theoretical generalisations about smaller and medium-sized overseas shares.

Put another way, in theory there is no difference between theory and practice. In practice, there is.

Ian Cowie is a freelance contributor and not a direct employee of interactive investor.

Ian Cowie is a shareholder in Baillie Gifford Shin Nippon (stock market ticker: BGS), European Assets (EAT), Indian Capital Growth (IGC), JPMorgan Indian (JII), JPMorgan US Smaller Companies (JUSC) and VinaCapital Vietnam Opportunities (VOF) as part of a globally diversified portfolio of investment trusts and other shares.

These articles are provided for information purposes only.  Occasionally, an opinion about whether to buy or sell a specific investment may be provided by third parties.  The content is not intended to be a personal recommendation to buy or sell any financial instrument or product, or to adopt any investment strategy as it is not provided based on an assessment of your investing knowledge and experience, your financial situation or your investment objectives. The value of your investments, and the income derived from them, may go down as well as up. You may not get back all the money that you invest. The investments referred to in this article may not be suitable for all investors, and if in doubt, an investor should seek advice from a qualified investment adviser.

Full performance can be found on the company or index summary page on the interactive investor website. Simply click on the company's or index name highlighted in the article.