Last week during meetings with two wealth management firms I enquired whether they might wish to meet a couple of companies favoured by LCFR and who have track records for delivering attractive returns to investors. In each case I was told that the firms concerned adopt a very risk averse investment stance on behalf of their clients and therefore focus only on very large companies. This set me thinking along the following lines:
Guy Thomas has written Free Capital, which chronicles the investing styles of twelve UK private investors, each of whom has made £1 million or more - in most cases considerably more - from investing. Stockopedia carries an interview with Mr Thomas which can be accessed by clicking here. Therein is a section referring to the fact that most of the investors covered focused on smallcaps and explaining why in the smallcap universe private investors can have an edge over institutional investors.
In addition to the market related factors given by Mr Thomas, I believe that there are also commercial reasons why it is possible to select smallcaps which can sustainably deliver better returns than large corporates - Jim Slater said 'elephants don't gallop' and here are my views as to why this is the case:
- Culture; one of the key features which I judge in potential investees is whether they are likely to make good decisions on behalf of shareholders. My experience based on transactions involving very large corporates and feedback from very able individuals with experience of working within very large corporates is that their decision making processes frequently stifle the creativity of able individuals.
- tThe long term driver of value creation is step change innovation rather than incremental innovation of existing products and/or services.
- Step change innovation is frequently originated by individuals with a somewhat maverick mindset, which the culture referred to above finds very difficult to accommodate, resulting in many innovators seeking to commercialise their knowledge via smallcaps.
- Where the smallcap develops innovation with significant potential, a large corporate will frequently buy it in order to replenish its new product pipeline. Generally it has to do so at a generous price in order to prevent a competitor from acquiring it.
I strongly believe that it makes sense for there to be a smallcap allocation within any portfolio, particularly to those smallcaps with the potential to fall within the cycle described above. In…
