Blue-chip investors could do worse than buy smaller stocks to sidestep any hit from global economic turmoil, analysts said on Friday.
City firms expect smaller companies to eclipse their larger counterparts later this year as they offer greater growth prospects and protection against turbulence.
Analysts at broker Berenberg said: “Heading into the latter months of 2015, we expect the smaller stocks under our coverage to outperform as they exhibit greater potential for earnings estimate upgrades, while any upside risk for many of our larger stocks seems to be mostly priced in.”
Currency devaluations by China, Kazakhstan and other Asian nations have rocked global markets and sparked fresh scrutiny of best investment options.
The currency interventions have triggered uncertainty about the timing of interest rate hikes by the US Federal Reserve.
Dire manufacturing figures from the US and China have also caused stock markets to question the health of the two big economies.
The data has hit commodity prices as traders fret about Chinese demand for metals.
Meanwhile oil prices have tumbled on a supply glut as US shale producers and Middle East oil sheikhs battle to dominate global crude markets.
And Greece continued to spark jitters in dealing rooms, with latest uncertainty caused by news of possible parliamentary elections in September.
Domestic exposure
Broker Berenberg has met more than 125 UK corporates with a market capitalisation lower than £4bn from different industries and now covers 26 such stocks.
It said companies consolidating in a fragmented market, expanding or having exposure to structural growth trends were attractive.
Stocks with those qualities such as veterinary services firm CVS Group (LON:CVSG), funeral director Dignity (LON:DTY) and takeaway chain Domino’s Pizza (LON:DOM) had done well so far this year, it said.
Small and mid-cap stocks have proved popular in 2015 with the FTSE 250 and FTSE SmallCap indices up by 8% and 6.5% respectively.
Meanwhile, the FTSE 100 Index is down in the year to date. On Wednesday, the Footsie closed at its lowest level since January 14, when it stood at 6,388. On Friday it was trading down 91.39 points at 6276.
Berenberg said investors seeking cover from economic turbulence have been studying smaller companies with less exposure to world markets.
The broker’s analysts said in a note: “We believe investors have been attracted to the UK mid-cap sector due to the higher domestic exposure found in these shares, given the global volatility, and the propensity for smaller companies to exhibit higher growth rates than larger peers.
“Indeed, many of the top performers among our coverage have been smaller companies with limited exposure outside the UK.”
Broker Brewin Dolphin said European small-caps had yet to capture the same investor interest as their large-cap counterparts.
But the continent’s small-caps should achieve higher absolute returns than large-caps in the long-term, it said.
Small-caps will also benefit disproportionately in the near-term from a rising European market.
Brewin fund analyst Anna Haugaard told Proactive Investors: “As the euro has strengthened against the dollar following China’s devaluation, we expect small-cap stocks in Europe to outperform larger companies.
“That’s because they’re much more domestically focused than large-caps which have more exposure to Asia.”
Haugaard said the longer term investment case for smaller companies was also compelling because smaller stocks tend to get less analyst coverage, increasing the scope for investors who research those shares to win higher returns.
Overweight on mid-caps
The average UK fund manager has returned 6.2% so far this year, compared with the FTSE All-Share which has returned 2.1%.
Broker Hargreaves Lansdown said active fund managers had beaten the index because they were overweight on mid-cap stocks - FTSE 250 excluding investment trusts - which have returned 11.1% so far this year .
Hargreaves senior analyst Laith Khalaf said: “Medium-sized companies tend to be more UK-centric than the blue-chips, so for many a slow-down in China will have little direct impact on earnings.”
Khalaf said UK managers had also benefited from being less invested in the beleaguered oil and gas and mining sectors early this year.
“So, while the commodity rout and the slowdown in China has significantly dented the FTSE 100, investors in actively managed funds might find they have dodged this bullet,” Khalaf said.