Small caps look too expensive
“You may think the past month or so has been bad for the stockmarket,” says Heather Connon in The Observer. But the small-cap sector has fared even worse.
It’s down 13% in the period, versus a 10% drop in the FTSE All-Share. After five years of smaller stocks outperforming, it seems bigger stocks are coming back into favour.
A typical fund in Morningstar’s UK Large-Cap sector has returned 21.1% a year over the past five years, says the fund adviser, against 29.6% and 24.8% for the typical small- and mid-cap funds. But smaller firms now look expensive, with the FTSE 250 and FTSE Small-Cap indices on respective p/e ratios of 14.7 and 15.6.
The FTSE 100, on the other hand, is on a p/e of 12.3 and looks more attractive to increasingly risk-averse investors. “Right now, good managers are saying, ‘our portfolios have moved up the cap scale. That mid-cap stock is on 22 times (earnings), but it was on 12 times when I bought it. I can’t see value there,’” Thames River Capital fund of funds manager Gary Potter tells Reuters.
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Large caps are seen as safe havens in times of uncertainty, says Morningstar, which makes them particularly appealing now when the full impact of the US subprime crisis is not yet clear. “Bigger companies typically have lower leverage, less cyclically dependent earnings and a relatively larger customer base spread around the globe than their smaller-cap rivals,” says the adviser. So “assets are typically directed their way when markets are volatile”.
That’s why fund managers have been shifting weightings upwards, some from as far back as 18 months ago. “Large-cap stocks generally got as cheap as at any stage since 1992,” says Rob Burnett, manager of the Neptune European Opportunities fund. “Small caps have outperformed for nine years. Yet the longest period of outperformance by small caps in the last century was 9.6 years,” he tells Fund Strategy.
The best way to get exposure to the FTSE 100 is through an Exchange-Traded Fund, such as the iShares FTSE 100 ETF (ISF). But while large caps may outperform small stocks going forward, that doesn’t mean you’ll make any money – some experts fear the FTSE 100 will end next year below today’s levels (see Investors: brace yourselves for a rocky ride).
A better bet is to invest in the sectors propping up the index – strong gains for oil and commodities have offset falls in financial stocks. You can track the price of most commodities as well as oil, via Exchange-Traded Commodities (see ETF Securities). Alternatively, the Merrill Lynch World Mining Trust (MLWT) gives wide exposure to the global mining sector and looks good value on a discount of 13.6%.
