The FTSE 100 index has been hitting dizzy new heights this month, breaking through three intraday records over the last couple of weeks. The UK large-cap index has gained bullish momentum with the rise driven primarily by healthcare, energy and financial stocks.
Shares in oil company BP soared after the company revealed its profits had doubled to US$28bn (£23bn) in 2022, as it benefited from the sharp increase in gas prices linked to the Russia-Ukraine war. The FTSE 100 contains mining firms such as Rio Tinto and Anglo American, as well as the oil majors Shell and BP.
It also contains utilities such as power and water suppliers, consumer-focused companies such as Unilever, the supermarkets Sainsbury’s and Tesco, banks including Barclays, Lloyds, HSBC and NatWest, the pharmaceuticals firms AstraZeneca and GSK, and the industrial groups Rolls-Royce and BAE Systems.
In all the hype over the new records set, investors with a long-term view mustn’t forget about smaller companies for their portfolios. It’s a tried and tested investment strategy to back the stock-market minnows and wait to cash in when they hit the big time.
There are plenty of opportunities in the FTSE 250, FTSE Small-Cap and the Alternative Investment Market (Aim), often referred to as Britain’s ‘junior’ stock market. There’s also the MSCI World Small Cap Index. Downturns are traditionally challenging periods for smaller companies. At the moment they are grappling with high interest rates, inflation and high energy costs among a whole host of things. Yet over the longer term – and especially in the recovery phase – UK small caps outperform their larger peers.
Right time to buy
Selectively buying small companies during a recession – or on the edge of recession as we seem to be in — means that you pick up well-priced stocks at a time when they are about to hopefully start on an upward trajectory. That’s why now might be the time – if you haven’t already — to look beyond the big beasts of the market and find buying opportunities among smaller firms.
One criticism of the FTSE 100 is its lack of innovative companies such as cutting-edge technology firms. But in smaller companies you’ll find plenty of innovation. Aim, for example, is home to thousands of fledgling businesses. Success stories include the tonic maker Fever-Tree, package holiday seller Jet2 and the video games support company Keyword Studios — each are today worth more than £1bn. There are many more success stories of course where smaller firms have been top performers.
Not all small companies will be a success of course. A typical problem with smaller companies is they are more likely to simply fail – and many do. However, those that succeed could see share prices follow revenue and profit growth over the long term.
Diversify through funds
For private investors, it might be too daunting to try and pick the individual winners. Funds specialising in smaller companies can help spread the risk as expert managers select the stocks on your behalf. Managers will typically be on the lookout for a company that has come up with something innovative that will see it grow faster than the economy and broader market.
There are opportunities in UK smaller companies, as well as global firms and those in emerging markets too. As well as funds – and investment trusts – run by managers there are tracker funds that offer exposure to the FTSE 250 and FTSE Small Cap indexes by simply mimicking the index.