Backing smaller companies investment trusts just ahead of the 2003 recovery produced spectacular gains, and the strategy is also likely to produce big gains this time around. Smaller companies often fall furthest in a bear market as investors cling to safer assets. But small caps can outperform on the way up, too, making it easy for investors to make big profits. And you can increase your gains and reduce risk by buying exposure through small-cap investment trusts trading at a discount.
One source of consolation during a bear market as torrid as the one we've experienced for the past 19 months is that when the recovery eventually arrives, there is a good chance that it will produce some phenomenal gains over a relatively short period of time. Markets tend to overshoot both on the way up and on the way down, which means an extreme bear market tends to leave exceptional value in its wake.
The potential for value to go unnoticed is highly evident at the moment. Bear market rallies have produced successive false dawns and the seemingly endless share price falls mean investors are turning the concept of value on its head.
But this extreme pessimism won't last forever. And after the UK's key indices bottomed out at the end of the last bear market, in March 2003, it was smaller companies that really outperformed. In the year following the trough, the FTSE Fledgling surged 95 per cent - three times the rise put in by the FTSE 100.
Will history repeat itself? There are already some signs that it might. The FTSE Small Cap outperformed the blue-chip index in the first quarter of 2009 - the first outperformance by small caps during a calendar quarter since the bear market began. And while Aim has had a dreadful two years, it has never fallen three years in a row.
The task of assembling a portfolio of well-researched small-cap opportunities can simply be outsourced to a fund manager by buying shares in a UK smaller companies' investment trust. These can produce spectacular returns when a recovery sets in; in the year following the last bear market 10 out of the 13 UK Smaller Companies investment trusts we've looked at outperformed the FTSE Small Cap index and all of them trounced the All-Share. And another beauty of investment trusts is that right now, you can buy them at big discounts to net asset value - meaning you're getting shares at even less than their bombed-out market prices!
