Setback in 2011 but smaller companies

In the “Silver Jubilee” edition of their annual Hoare Govett Smaller Companies Index (HGSC) report, Professors Elroy Dimson and Paul Marsh review small-cap performance in detail.


In 2011 investors in smaller companies experienced disappointing returns in 28 out of 29 countries, according to research from London Business School professors Elroy Dimson and Paul Marsh.

However, this setback followed two excellent years, and a strong performance since 2000, with small-caps outperforming large-caps by 7% per annum worldwide. The professors point out that while it was a “lost decade” for large-cap equities, small-caps did well.

The HGSC monitors the performance of the smallest tenth by value of UK quoted companies. The 25th annual report, published in conjunction with RBS, reviews long run performance over the 25 years since the HGSC went live, and the full 57-year period including its backhistory. Over the past 57 years, the HGSC has beaten the FTSE All Share by 3.2% per year.

The report documents the rise of mid-cap companies and highlights their excellent performance since 2000 and also analyses the disappointing performance from AIM stocks and other junior market securities.

New flotations (IPOs) are the lifeblood of equity markets, and most IPOs are smaller companies. In 2011, IPO activity remained low and the hoped for pick-up after strong equity markets in 2009/10 did not materialise. Professor Marsh explained:

“This could be because IPOs were overpriced, or because of poor subsequent performance. To check this out, our report has analysed every UK IPO (large and small) since 2000. We found that while the initial market reaction was favourable, and does not indicate overpricing, there were large losses over the next two years. It’s been a decade of disenchantment for IPO investors.”

The FTSE 100 is often criticised for not being truly British. While this may be unfair, could a smaller companies index like the HGSC provide a better bellwether of British business performance? Professor Dimson responds:

“We find that even smaller UK companies are surprisingly global, with almost half their revenue from overseas. We show that there is little link between stock market performance and ‘domesticity’. Since 2000, the HGSC has been the best performer, despite being less global than the FTSE 100. Yet the worst performing index has been the FTSE UK Local Index, which excludes multinationals.”

The dividend cuts that investors suffered in 2009 were the most severe on record; but the report shows that dividends have since recovered strongly. The authors debate whether this a (good) sign of managerial confidence, or a (bad) sign that corporates cannot think of anything better to do with their cash.

The report covers a wealth of other topics, including (a) the long run record on UK acquisitions, examining why activity is currently low, and whether this matters, (b) the long run record on bankruptcies, showing a sharp fall since the all-time high in 2009, and (c) the impact on smaller company performance of factors such as value and growth, size, and momentum. Over the long run, momentum and value effects have been very strong, both in the overall UK equity market and among smaller companies. The report shows that within the HGSC, smaller value stocks have generated the best long run returns, beating growth stocks by 6-7% per year.