The Future is Small: Why AIM will be a World Beater
Gervais Williams, author of The Future is Small: Why AIM will be the world’s best market beyond the credit boom, makes the case for this most dynamic of markets.
Recent years have been a tale of interest rates being held at record low levels, governments running sizeable budget deficits and the use of huge amounts of Quantitative Easing (QE). But rather than renewed world growth coming through, we’re all still in the departure lounge waiting for take-off.
Some hope that the ‘three arrows’ of Abenomics (this refers to the economic policies advocated by the Japanese prime minister, Shinzo Abe, will reverse the trend. These are fiscal stimulus, monetary easing and structural reforms).
Others point to the European Central Bank (ECB) commencing asset purchases through its own version of QE. However, even in the US where everything has been tried, in scale, low bond yields continue to foretell a story of slow growth.
For those with a metrological bent, it’s easy to explain. On the windward side of a range of mountains, extra rain comes from clouds forced higher over the peaks. But beyond the watershed there’s little rain as the spent clouds descend. It’s called a rain shadow. The world seems to be entering a growth shadow. For the last two or three decades we have been borrowing growth from the future. Now it’s payback time.
It’s a big challenge, as most asset classes appear unappealing. Yields on Government bonds, and even corporate bonds are meagre. Property yields might be a little better, but there are sorts of extra costs that come with property. It seems that most investors already have their fill of mainstream income equities too. These questions are the focus of my new book, The Future is Small, – it explores the investment landscape in a world where growth remains sub-normal.
In this context, we’re incredibly lucky to have the Alternative Investment Market (AIM), one of the world’s most developed markets for genuinely small companies. It is a ray of light in a troubled world.
Not because every year there are some tiny stocks that feature amongst the UK’s top stock market performers – but rather because smaller companies in general have more growth potential than larger businesses. That hasn’t been important during the boom when growth was plentiful. But with so many larger companies now running out of steam, it’s suddenly become horribly relevant.
‘In this context, we’re incredibly lucky to have the Alternative Investment Market (AIM), one of the world’s most developed markets for genuinely small companies. It is a ray of light in a troubled world’
In the past, small and micro companies saw us through because some can grow even when the economy is flat. Smaller companies outperformed for decade after decade prior to the credit boom. Surely the decision is simple. Surely institutional investors should build their weightings in the smallest quoted companies up to perhaps 10% or maybe even 15% of their UK equity portfolios.
However, I believe there are a load of reasons why many are reluctant. At present it is getting harder to find attractively priced equities that can deliver sustained expansion especially in an investment climate where world growth is limited.
‘It is getting harder to find attractively priced equities that can deliver sustained expansion especially in an investment climate where world growth is limited’
Clearly small and micro-sized companies will also find it more difficult to grow at challenging times. And markets are also becoming more unsettled and volatile, so the natural inclination suggests that there is even less reason for institutional investors to take on extra illiquidity risk through investing in more small companies.
It’s conventional wisdom that larger companies have the advantage of resilience that comes with their scale and greater access to finance. If times are tough then micro caps don’t seem to be the way forward.
However, the problem is that growth amongst most of the largest stocks is tightly linked to the growth of the wider economies. A glance back to the 1960’s or the 1970’s is instructive. The key point was that world growth was sub-normal, and so was the growth generated by the largest stocks. Strangely enough it was the very smallest listed stocks that outperformed. They outperformed because they have greater growth potential – and that extra growth potential really counts when the economy is flat.
Historically, it wasn’t the largest stocks that delivered the best performance during these troubled times. That may not suit those with a nervous disposition who recollect the frequent recessions and the horrors of the 1974 market crash. Smaller companies outperformed because there were able to find small capex opportunities that delivered decent paybacks in a relatively short timetable.
Being quoted meant they had access to extra capital at a time when most private companies were more constrained. And those extra cash returns were reflected in extra dividend growth.
That is the bottom line – superior dividend growth over years and decades ultimately will not only drive relative performance, but also portfolio allocation. Despite the unsettle market background small and microcap stocks attracted sustained institutional support. The key point was they were able to grow their dividends at time when most larger companies were trapped by their sales flat-lining.
But for now many institutional portfolios have negligible amounts of capital invested in the smallest quoted companies. Over the last couple of decades when growth has been plentiful, it hasn’t been necessary to access the greater growth potential within the smallest quoted stocks. During a period of globalisation it has been easy for many to increase their attention on the largest stocks that have taken advantage of the supersonic growth in the emerging markets.
But wait a moment… something strange has started happening in the markets. Dividend growth amongst the largest companies is running out of steam in part due to the FTSE 100 dividend cuts. The disappointing economic trends are now holding back dividends. But meanwhile dividend growth from the smallest stocks has been stepping up. In part because dividend cover amongst the smallest stocks is coming from higher levels.
In part because some smaller companies are sustaining decent growth in spite of a slowdown in world growth. And in part because many of the smallest stocks have much less debt. Indeed many have net cash balances.
This is beginning to sound familiar. The attractive dividend growth is likely in my view to become the overriding reasons why institutional investors will surprise themselves by progressively increase their participation in smaller companies from here.
Even small, additional increments of institutional allocations will start to drive up the small cap market. As the smallest stocks outperform the commercial imperative to participate will become more urgent. The wave will roll right down to the bottom of the market since the smaller company effect is proportionate. In the past the best returns have come from the micro caps.
So this is not just a case of a period of small cap performance catch-up, it’s a structural change in the market trends. Expect a new super-cycle of AIM market returns over the coming decades.
Gervais Williams’ book The Future is Small: Why AIM will be the world’s best market beyond the credit boom is published by Harriman House. The views expressed in The Future is Small: Why AIM will be the world’s best market beyond the credit boom are the views of the author in his personal capacity. It does not constitute any form of specific advice or recommendation by the publisher, editor, author or author’s employers and is not intended to be relied upon by users in making (or refraining from making) investment decisions. Appropriate independent advice should be obtained before making any such decisions.
Past performance is not a guide to future returns. The value of investments and any income may fluctuate and investors may not get back the full amount invested. This fund may experience high volatility due to the composition of the portfolio. Investment in the securities of smaller and/or medium sized companies can involve greater risk than may be associated with investment in larger, more established companies. The market for securities in smaller companies may be less liquid than securities in larger companies. This can mean that the Investment Manager may not always be able to buy and sell securities in smaller and/or medium size companies.
The views expressed are those of the fund manager at the time of writing and are subject to change without notice. They are not necessarily the views of Miton and do not constitute investment or tax planning advice. The mention of specific stocks must not be construed as a recommendation to deal. Whilst Miton has used all reasonable efforts to ensure the accuracy of the information contained in this communication, we cannot guarantee the reliability, completeness or accuracy of the content. Miton is a trading name of Miton Asset Management Limited (FRN 115241) and Miton Trust Managers Limited (FRN 220241) incorporated and registered in England and Wales (with its registered office at 51 Moorgate, London EC2R 6BH) and authorised and regulated by the Financial Conduct Authority.