Money: Big need not be better

Smaller companies are unfairly missing out on the stock market action

Has the stock market gone mad? New highs were being posted on both sides of the Atlantic as the week progressed. The demand for financial assets has been as strong as ever and forecasters have been busy pencilling in even larger numbers for the year end.

But make no mistake - this is a very thin bull market. All the action is taking place in the bigger market capitalisation stocks. And that applies just as much in the States as here.

It is worth bearing in mind that the Dow Jones Industrial Average, which everyone still quotes, covers just 30 shares. In the old days, the bellwether for the UK market was the FT Industrial Ordinary Index. This had just 30 shares too, but it was replaced in terms of credibility by the Financial Times Actuaries All Share Index.

This was the one which fund managers knew was most representative of the market. Now it includes more than 700 shares and covers over 90 per cent of the London stock market by value.

More recently, the FTSE 100 Index has gained a credibility that is alarming. So many tracker funds are based upon this index that the possibility of inclusion is likely to attract buying interest and thus accelerate the process of moving into the UK's top 100 companies. The same thing happens in reverse. It creates an artificial environment which can influence the action of companies and distort the performance of a share.

It is interesting to contrast the performance of the FTSE 100 and the Actuaries All Share Index, which includes a large number of smaller companies. The FTSE is well in the lead. It is clear where the smart money has been going.

In the USA, Dow Jones has always been precious over the way in which its index is used, but competitors have not made the in-roads that might have been expected. Derivatives are changing all that.

Linking a contract to an index has become a favoured way of betting on the market move or, for more considered investors, hedging an existing position. Even the mighty Dow Jones has had to bow to this pressure. Soon we will be trading contracts based on this, the oldest of all the world stock market indices. And as with the UK, the Dow Jones Industrial Average is outperforming the more broadly based indices.

Why should smaller companies be so out of favour? Small companies are the lifeblood of the market. The best of them turn into large companies. The first problem is deciding just what constitutes a small company. I have colleagues who consider the cut-off point to be a pounds 1bn market capitalisation. A market capitalisation of pounds 1bn these days puts you firmly down into "Tootsie" - the second 250 shares quoted in London. Amazing to think you can be worth so much money but still be playing in the second division.

Quite why investors these days should be so focused upon the larger, more liquid stocks is not entirely clear. But with more investing power concentrated in the hands of major institutions, it is perhaps understandable that they like to deal in shares that they can easily acquire - and easily ditch again if they change their view. What it does do is throw up some considerable opportunities among smaller companies.

That small company shares can reward handsomely is evident, even if the indices do not suggest pursuing them is a profitable pastime. I only have to look at my portfolio on Sky to see what can be achieved.

Trailing my two competitors, it was clear that the route I was taking - responsibly buying typical private-client shares, FTSE 100 companies that everyone had heard of - was not paying off. Matthew and Justin concentrated on smaller issues and were knocking my performance into a cocked hat. A change of tack and I had soon caught them up, leaping into the lead at one stage. Indeed, one other portfolio reverted to blue chip holdings and started to lag the others. It was strange how what was actually happening did not seem to be borne out by the indices.

There are some small company funds around but they have not been doing too well of late. If you have your full allocation of the blue chips, then it is perhaps worth a speculation in one or two smaller companies direct.

This is a theme to which I will return, but in the meantime my tip for this week is Silvermines, a company to which Greig Middleton acts as a stockbroker. Do not be deceived by the name. The company operates in the field of electronics and electrical equipment. With the shares having fallen dramatically, the market capitalisation is less than pounds 50m, but we think this understates the true value of the company. One to tuck away in larger, well-diversified portfolios.

Brian Tora is chairman of the Greig Middleton investment strategy committee and may be contacted on 0171-655 4000