The best global smaller companies funds

Under-researched and with plenty of growth potential, smaller company stocks tend to offer a compelling narrative for investors. But often this is something of a local affair, because UK investors those who invest directly in stocks tend to gravitate to UK-listed shares, while funds with a focus on UK small caps often prove popular, too (‘The best ways to back British small caps’, IC, 11 April 2023). Investment Association data shows that its UK Smaller Companies fund sector had £11bn in assets under management at the end of April, well above the £4bn in North American Smaller Companies sector funds or £2.1bn in European Smaller Companies funds.

Investing in an overseas-listed smaller companies fund can be a niche choice and not everyone wants the complications of picking a smaller companies fund for each of the major equity regions. UK-listed smaller company shares can be risky enough – a reason why some investors would rather prefer not to look further afield. Tom Sparke, investment director at discretionary fund manager GDIM, argues: “Looking at smaller companies in emerging markets can come with significantly increased liquidity and transparency concerns, so this would not be my first port of call.” He instead has tended to prefer global smaller companies funds, because their reach can extend far. Although overseas-listed 'smaller' companies stocks can be larger than their UK equivalents, they still have the potential for significant growth over time.

The options are wide-ranging. As an example, one long-term strong performer, Herald Investment Trust (HRI), has done well from its focus on telecoms, multimedia and technology shares across the world, although it can hold some names that commonly appear in other UK equity funds. For example, at the end of April its 10 largest holdings included Next 15 (NFG) and YouGov (YOU), two Aim stocks that are popular with many UK equity fund managers. However, Herald tends to have an enormous number of holdings, with 338 at the end of April, meaning that the risk of too much exposure to one stock is fairly limited.

Herald has tended to have a decent weighting to the UK, with domestic shares making up 44.6 per cent of its portfolio, compared with 23.3 per cent in North America and 11.4 per cent in Japan and Asia Pacific at the end of April. That is in contrast to the US bias which a number of global smaller and larger companies funds have. This is especially clear with Edinburgh Worldwide Investment Trust (EWI), managed by Baillie Gifford. This trust is a much more adventurous option, and had a 72 per cent weighting to North America at the end of April, as well as big allocations to high-risk, high-reward sectors such as biotechnology. We’ve previously noted that this can serve as a “blue sky” portfolio (Edinburgh Worldwide: a "blue sky" fund faces trying times, IC, 13 May 2022) because it holds some initially immature entrepreneurial companies – both listed and unlisted – the best of which could offer huge returns over the longer run. Edinburgh Worldwide’s managers tend to run its winners when they succeed, explaining why mega-caps such as Tesla (US:TSLA) have previously featured prominently in the fund. The fund’s biggest position at the end of April was another Elon Musk venture – Space Exploration Technologies.

A fund with more of a staid approach is Abrdn Global Smaller Companies (GB00B777SP34). It has built up a strong track record over the years thanks to its stock screening process, which focuses on factors such as share price momentum, director dealing and earnings per share growth. Its investment team has also tended to closely assess companies' market shares, pricing power and barriers to entry, while its screening also aims to identify companies undergoing positive change. The fund has a mixture of country exposures outside the US, and its largest holdings at the end of April included Axon Enterprise (US:AXON) and Keywords Studios (KWS). It also has a decent mixture of industry sector exposures.

Going granular

There is still a strong case for a focus on the US given the sheer size of its economy. We have highlighted some dedicated US smaller companies funds in our IC Top 50 Funds lists of years gone by and include Brown Advisory US Smaller Companies (BASC) in the most recent version. Our specialist panel highlighted this fund for reasons including its investment team’s strong track record, and a focus on companies that have durable growth, well-aligned management and scalable market strategies and respect shareholder interests.

With small-cap portfolios having sold off in the past year, investment trusts offer some notable share price discounts to net asset value (NAV). Brown Advisory US Smaller Companies was recently trading at a discount to NAV of 12.3 per cent, although this is slightly tighter than its 12-month average of around 13 per cent.

Other names stand out in less high profile regions, with the caveat that most of these funds have suffered a challenging 12 months, given that smaller company investing tends to involve a growth bias. Montanaro European Smaller Companies Trust (MTE) has done well in the longer run because of its focus on quality growth metrics in what is often an unloved region. There’s a similar story in Japan – much as the region has not always excited investors, Japan smaller companies portfolios have made some stellar long-term returns. It’s notable that M&G Japan Smaller Companies (GB00B7FGLY29), which has something of a focus on undervalued companies and a multi-cap approach with a bias to smaller names, has made a sterling total return of more than 235 per cent over 10 years.

Backing an extra fund in a given region (in addition to an all-cap or mainstream portfolio) may not be popular with investors who only have a small allocation to that region in the first place. However, it can make sense to have a global smaller companies fund alongside a global fund focused on larger companies, as well as a UK smaller companies fund alongside a fund focused on larger companies. Specialists maintain that active managers have something of an edge here. It’s also worth noting that some managers of mainstream UK funds can and do take an ‘all-cap’ approach, meaning that they include some smaller names alongside larger companies. You can often see whether this is the case in a fund's literature, such as its monthly factsheet.