. Indeed, the fall has left the Small-Cap category neck and neck with our UK Large-Cap Blend group over the past three-years.
One could argue that with the higher volatility of small-cap offerings, such a return isn't worth bothering with. We think that's missing the point. Small-caps can and do offer more fertile hunting ground where robust research can pay off--the market is just less efficient as fewer of the companies receive robust coverage by analysts. However, there are real risks: First, some funds invest extensively in AIM shares, which come with a high degree of business risk--adding to the high level of risk already inherent in smaller companies. Moreover, small-caps are much less liquid than large-cap shares, so trading activity can buffet their share prices much more easily. This can impart significant additional volatility and raise trading costs substantially.
So who's been most adept at making those risks pay? We'd be remiss if we didn't mention Dan Nickol's Old Mutual UK Select Smaller Companies. Nickols and his small-mid cap team at Old Mutual have shown a decided flair for stock picking in the lower bands of the UK market-cap range. The fund's cash level had also risen to 9% by the end of 2007, and contributed to its relative strength in the fourth quarter, leaving it with the second best five year record in the sector. The fund is capped currently, which is good given liquidity constraints in the sector. However, although we like Nickols, we remain concerned about the fee level here. With a total expense ratio of 1.92%, it has a bigger hurdle to overcome than many of its rivals do.
The other fund that's hard to miss is Giles Hargreave's Marlborough Special Situations--the only fund to beat the Old Mutual offering over the past five years. We like this fund's combination of experienced management and an enviable record at a lower cost than the Old Mutual fund. It is a different kettle of fish, however--Hargreave invests heavily in micro-caps (58% as of 31 January) and Aim listed shares, elevating the fund's fundamental risk. Even though Hargreave mitigates that by spreading the fund's assets across a large number of holdings, it has been a streaky performer, with a decidedly sub-par two-year stint from 2005 to 2006.
For a good all around small-cap fund, we still believe it's hard to do much better than Harry Nimmo's Standard Life UK Smaller Companies. It offers experienced management and reasonable costs and boasts a record of strong, consistent performance relative to its peers. It also spreads its assets reasonably broadly across individual issues, with 72 holdings and 23.6% of assets in the top 10 as of 31 January. It is unlikely to offer the occasional sizzle of the Marlborough offering, but we believe it's a better choice for mainstream small-cap exposure.
A version of this article previously appeared in Investment Adviser, Financial Times Ltd.
