Defiant Swedes keep faith in small caps

16 February 2015

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PA Europe

Though small caps significantly underperformed large caps in 2014 in the US (the region most popular with local fund selectors at the moment), fund buyers attending Expert Investor Stockholm last week are overwhelmingly in favour of the former. Almost two thirds of them prefer small caps, while only 6% see more value in S&P 500 companies.

For European equities, the picture is rather similar: 56% favour small caps, compared to just 22% preferring large caps. EM equities are the exception though: for this asset class, the Swedes overwhelmingly stick to large caps. In the rest of Europe, it is rather different. Only in Denmark, small caps are more popular than large caps for both US and EU equities. Fund selectors in almost all other countries have a firm large cap bias.

Is it the right call?

So is the Swedish small cap bias risky and should they consider switching their attention to larger companies now? For US equities, their traditional focus on smaller companies had been the right one in the first 13 years of this millennium, when small caps consistently outperformed large caps. But over history, periods of small cap outperformance have always been alternated with large caps performing better. The last period of small cap outperformance having lasted 13 years, we might now have entered an era where large caps will do better. Considering the high valuations of many smaller companies, this does not seem unlikely.

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However, and reassuringly so for the Swedes, a period of rising interest rates (which is now on the cards in the US) has historically coincided with US small cap outperformance (see graph above). Large caps in the US also tend to be more export-dependent than the more domestically orientated small cap stocks, which strongly speaks for the latter. In a time of an exceptionally strong dollar, US exporters see their competitiveness and profitability eroding rapidly.

ECB stimulus

Swedish investors are not as upbeat about European equities as the rest of Europe, but there is a consensus among them that the ECB’s QE programme will mainly benefit equity markets. In combination with the devaluation of the euro which is the consequence of the ECB’s money-printing, small cap stocks are well placed to benefit, says Andrew Paisley, a European small cap equity manager for Standard Life who spoke at Expert Investor Stockholm.

“In the short term [the cheaper euro] will be good for the industrial sector and for exporters. This is the largest segment of the small cap universe,” he said. So even though small cap returns are unlikely to be as high as they have been in the recent past (with the Carnegie Sweden Small Cap Index returning 36% in the past 4 months), Swedish fund selectors may still find themselves in the sweet spot…