Trustnet Magazine 86 July 2022 | Page 50

SECTOR PROFILE

Favouring the brave

Smaller companies are invariably among the biggest fallers when markets take a tumble , and this year is no different : while the IA UK All Companies sector is down 12.8 %, IA UK Smaller Companies has fallen 24.1 %. The growing threat of recession means there may be more pain to come for smaller companies . Yet the best time to buy an asset is often when sentiment is at its lowest point – so with small caps capable of delivering some of the highest returns over the long term , does this mean there may be a contrarian opportunity in the sector for investors with an incredibly strong stomach ? Neil Veitch , manager of the SVM UK Opportunities fund , says that while it is tempting to highlight the resilience of small caps through the Covid pandemic to suggest the worst is behind us , this would ignore the drivers of the current correction . “ Investors fear central banks are on autopilot and will only stop tightening when inflation has been wrung out of the system , even if this causes a deep recession ,” he says . “ Many small- and mid-cap stocks are heavily exposed to the domestic economy and are therefore vulnerable to an economic slowdown .” With a looming recession meaning there will be little respite in the short term , Veitch says that the decision of whether to buy small caps depends on an investor ’ s time horizon . “ The strong probability is that this is a cyclical , not structural , bear market ,” he says . “ Should inflation cool and nominal incomes hold up , the economy could recover sharply . Would this lead to ‘ growth ’ stocks reasserting themselves ? Perhaps in the early stages , but the next decade is likely to be characterised by higher inflation and higher discount rates , meaning that investors need to adjust their playbook accordingly .”
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