Two European Small Cap Fund Picks
Two choices stand above the rest.
Small-Cap Fund Downturn: Liquidity Matters
The last time we addressed the sector, we had pointed out it was ripe for a downturn, but we can't claim to have anticipated the huge amount of panic driven selling of high risk assets (small caps among them) that was precipitated by the subprime crisis. Nevertheless, the downturn provides a useful lesson: Whilst we had focussed on the valuation risk embedded in small-cap shares relative to historic norms, it was their liquidity risk that ended up making the situation as bad as it was. When you're running a large sum of money and need to get out of relatively less liquid names in a hurry, you're going to take a hit. The evidence from portfolios in the sector is reasonably clear on this point: The funds at the bottom of the charts over the past years tended to have sub £1 billion market capitalisations, and the worst had sub £500 million market caps. The funds that held up best tended to have average caps substantially in excess of £1 billion.
Fund Leaders: JPM Europe Smaller Companies
The sector, like all in the IMA system, suffers from the trade group's focus on serving its member firm's commercial interests rather than providing investors with a real peer group of investable funds. Because it is artificially constrained to UK domiciled funds run by IMA member firms, it contains just 16 offerings, many of which are not particularly good. Within these constraints, however, we continue to think highly of a few funds. JPM Europe Smaller Companies posted a middle of the pack loss over the past year, but that isn't bad considering how well it has fared during better times. Moreover, the fund benefits from highly experienced management and a reasonably well diversified portfolio, although we continue to watch its sizable industrials stake.
Fund Leaders: Threadneedle European Smaller Companies
We also like Dan Dudding's Threadneedle European Smaller Companies. It too features a large industrials weight, but these tend to be oriented towards Asian economies rather than Europe, which provides a degree of additional diversification, and their economic sensitivity should be offset to a degree by the fund's overweight in the relatively defensive healthcare arena. We are a bit concerned by the fund's size, but Dudding has a reasonably large pool to fish in, and it doesn't appear to be a problem at this juncture.
Fund Laggards: Melchior European Opportunities
Fund Laggards: Melchior European Opportunities
At the other end of the spectrum, we frankly have difficulty in seeing why Melchior European Opportunities continues to exist. It's costly, has delivered exceedingly poor performance, and has almost no assets to speak of. Further, although it is in the European Smaller Companies sector, it benchmarks itself against the broad MSCI Pan European Index, and carries a performance fee for beating the benchmark. Given that the index is large-cap oriented and has less than 1% in small caps, it doesn't make sense as a benchmark for a small-cap fund. The fund's performance fee is likely to hinge more on the performance of small-caps versus large-caps than on management skill, which rather defeats the purpose.
A version of this article previously appeared in Investment Adviser, Financial Times Ltd.
