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That shares in small companies deliver higher returns than those of their larger peers, provided you hold them for long enough, is well documented.
Less well-known is the fact that, according to research from fund group Montanaro Asset Management, the stock market trend is even more pronounced in Europe.
The investment firm periodically tots up data to keep track of the phenomenon in the annual report for its Montanaro European Smaller Companies Trust, which Questor tipped in May 2018.
In its latest tally of what it calls “the small cap effect”, Montanaro found that shares in small British companies had returned on average 3.4 percentage points more each year than London-listed blue-chip stocks since 1954. Compounding over 66 years, the difference in performance has been dramatic.
One pound invested in the shares of small British firms at the end of 1954 would have grown to £7,900 by the end of last year, more than seven times the £1,030 the same investment in large UK stocks would have made.
Across Europe, the data doesn’t go as far back, but the difference in performance since 2000 is even starker: shares in the Continent’s small companies have returned on average six percentage points more per year than larger firms.
The growth on offer from shares in smaller companies was what led Questor to recommend readers buy the Montanaro trust, coupled with the opportunities they presented for fund managers able to pick the best ones.
It’s another axiom of investing that stock pickers who focus on small companies tend to beat the market more than those who buy shares in large firms. Small firms tend to be less well researched than the stock market’s biggest companies, leaving more scope for the best fund managers to find winning shares before the rest of the market does.
George Cooke, manager of Montanaro European Smaller Companies, has done exactly that – and then some.
Since Questor tipped shares in his trust just over three years ago, they have returned 138pc, nearly four times as much as its benchmark and substantially more than any other trust investing in European shares has managed. Such has been the rise in its shares that the trust conducted a share split, handing investors 10 shares for each they held, this month.
“It’s done brilliantly and way above what a reasonable investor would expect, particularly given the period we’ve been through,” says John Moore of Brewin Dolphin, a wealth manager that holds the trust on behalf of its clients. “It’s a relatively concentrated portfolio, and they have hit a sweet spot.”
A small part of that return has come from the evaporation of the shares’ discount to the trust’s assets, which stood at 14pc at the time we tipped them. They now trade 1.5pc higher than the trust's net asset value, buoyed by strong demand from investors who have flocked to the shares amid the strong performance.
Montanaro European Smaller Companies is the only trust investing in Europe whose shares do not trade at a discount. Its three rivals focusing on smaller companies on the Continent all do, ranging from a discount of 4.2pc on shares in European Assets to 14.4pc on TR European Growth and 13.9pc on JP Morgan European Discovery.
The latter was tipped by this column, under its previous moniker of JP Morgan European Smaller Companies, in August 2019. Moore says the trust’s large discount means he is favouring it for new client investments and he has taken some profits from Montanaro European Smaller Companies’ stunning run.
“When a cricketer hits six sixes in a row, that’s magnificent, but you’ve got to be mindful of the fact that it won’t go on forever,” he says. “The same applies with investing – sometimes it’s good to take a bit of money off the table just to keep a balanced approach.”
Readers who followed Questor into Montanaro European Smaller Companies and are now enjoying substantial gains may want to do the same. This column does not recommend readers sell out, as Cooke’s strong performance makes his trust one to continue backing. But the lack of a discount means now is not the time to buy more of the shares. Hold.
Questor says: hold
Share price at close: 204p
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