The FINANCIAL — The 2008 Hoare Govett Smaller Companies (HGSC) Index report published today by ABN AMRO and London Business School professors Elroy Dimson and Paul Marsh shows that, after an unprecedented four-year run of strong absolute and relative performance, UK small-caps suffered in the turmoil following the credit crunch and liquidity crisis.
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According to London Business School, the HGSC Index measures the performance of the lowest tenth by market capitalisation of the main UK equity market, with a variant of the index (HGSC plus AIM) also including AIM stocks. The index was launched 21 years ago, and has a comprehensive history extending back 53 years to 1955.
The HGSC gave a total return of −5.9% in 2007, an underperformance compared to the FTSE All-Share of 11.2%. Also, the smaller the company, the worse its performance tended to be, and the HG1000 “minnows†index (ex-investment companies) underperformed by −18.7%. (Figure 1)
Elroy Dimson and Paul Marsh, professors at London Business School, and authors of the report said:
“Last autumn’s decline in sentiment for small companies was fast and severe, and smaller companies are now on a much lower rating than last year. Historically, the HGSC has beaten the All-Share in two years out of three, and cumulative performance from small-caps has been outstanding.â€
Richard Rae, Head of UK Smaller Companies at ABN AMRO said:
“The HGSC valuation is now close to parity with large-caps, but economic uncertainty will continue to overshadow the more cyclical sectors, in which the HGSC is overweight. We have a cautious stance on the short term outlook, but the indiscriminate sell-off will present some selective buying opportunities.â€
Over the previous four years, the HGSC Index has achieved annual returns between 20 and 40%, exceeding the All-Share in each year by 7 to 20%. Over multiple years, small-caps have performed well. Over the last nine years, the HGSC has returned 156%, beating the FTSE All-Share by 95%. A £1000 investment in 1955 in the HGSC, with dividends reinvested, would today be worth £2.76 million, as compared to £0.59 million if the investment had been in the All-Share.
The report shows that small-cap outperformance is not unique to the UK. Looking at performance statistics for 21 countries over the period 2000-2007, small-caps outperformed substantially in most markets. Over this interval, small-cap premia (the difference between small-cap and large-cap returns) were typically 4−9% per year. (Figure 2)
Large growth stocks within the HGSC (ex-investment companies) proved to be defensive in 2007 with a return of −1%, whereas value stocks fell by an average of 19%. Over the longer term, however, small-cap value stocks performed remarkably well, with a 53-year annualised return that was 8% above the HGSC’s growth-oriented stocks. (Figure 3)During 2007, stocks that had been relative winners in the previous year were resistant to market setbacks, but the losers from the previous year underperformed by as much as 32%. This has been a persistent pattern within the HGSC. In most of the last 53 years, portfolios of past winner stocks have beaten past loser stocks by a substantial margin. (Figure 4)
Other findings include:
There has been a big gap between the performance of companies based in the North and South. The South, where 80% by value of listed companies are located is home to the four regions whose companies performed best in 2007. The North, where only 20% by value of listed companies are located contains the six regions that performed worst in 2007. (Figure 5)
The price/earnings multiple for the HGSC (ex-investment companies) has fallen in one year from 18 to 12. The index’s P/E, which had been at an historic high relative to the equity market as a whole, is now lower than the overall market. (Figure 6)
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