Small caps to complement VLS

Legacy_user

Hi all,

Ive got a small amount of money invested in S&S ISA - currently sat in VLS 80. In terms of diversification (& potential long term returns), I realise that this tracker misses out on small cap exposure.

I have read several times that when you go for small cap, it is best to go active as it is an under researched area. But is this true in practice? I was looking at adding the vanguard global small cap index as a side holding.

Do most who hold VLS with satellite holdings tend to go active for small cap? From my research the only really strongly performing global small cap fund appears to be the global discovery fund from baillie gifford and it also quite cheap with OCF of 0.78%, however it is very tech/pharma weighted and thus prone to big sell offs in momentum trades. IP global smaller cos & SL global sm cos have failed to outperform the tracker over recent history.

In addition are there any other small cap trackers out there? The 0.38% OCF is a little pricey for a tracker (but obviously a lot cheaper than active if they aren't performing!)

badger09

I don't know enough about the various active small cap funds, and am not really prepared to put in the necessary time and effort to enable me to correctly choose the best, so I've added the Vanguard Global Small Cap to my VLS 100%.

But then I am probably much older than you and have come to investing very late in life

vickssinex

When I opened my S&S ISA in 2013 I opted for a 75:25 split between VLS 80 and the Cazenove Small Cos fund, which is now Schroders. This did very well for about 18 months and I didn't think the fees were too bad at 0.8%. The fund went off the boil though so last month I sold out, bought some more VLS and bought into the Axa Framlington smaller companies fund instead.

Linton

The Vanguard Global Small Cap fund as an index tracker invests predominantly in the largest companies in its index. Going for a fund that invests in large small companies seems a little perverse.

There are only a few global small companies funds of any type, perhaps because to be successful in this sector you need to have knowledge of the companies you are investing in and to manage this globally wouldnt be easy. If you want to go for small companies I suggest you start with UK small companies funds which in general have greatly outperformed the Vanguard Global one over the past 5 years.

bowlhead99

I favour active for small caps although did use Vanguard's tracker as some small part of my holdings in the time when smallcaps everywhere were shooting up.

It is quite heavily US focussed (60%) as you have seen (which makes sense given the global spread of market capitalisation generally) - so you would get more US and more tech than in your VLS which has a UK "home bias". It is of course questionable whether a market cap-weighted index (invest the most in the biggest) is quite what you are looking for, if you are deliberately aiming to increase your exposure to smaller companies... but it is a cheap and cheerful strategy.

The top end holdings might have a market cap of £5bn or so - its top 20 include all sorts from eTrade to Barratt, Goodyear, Rite-Aid etc. It will pick up a bunch of US tech and biotech companies as well as plenty of pharma or medical businesses, but the tech and health holdings are still not as big as banks/financials, industrials, consumer discretionary. And tech only looks big because there is so little of it in the FTSE - it's a pretty big sector on the world stage.

Looking at the full list of holdings at end of March, it has about 4300 total holdings worth a billion dollars in total. If you line them all up in a row, the bottom 660 companies are all below $50k in value - only $21 million worth of the billion portfolio, in all those companies. While at the top end, the top 20 companies alone have an aggregate value of $30m. So, the holdings are very much concentrated in the larger companies but with your money at work in lots and lots of companies around the planet it will still be diversified. But highly correlated with the US smallcap index, because that's what the majority of the holdings, by value, are.

I don't think the 0.38% OCF is crazy unreasonable for access to thousands of companies across the planet which you wouldn't be able to access yourself at the amounts you have to invest. The turnover rate is about 6% and there will be some inefficiencies investing back and forth in smaller companies rather than (e.g.) simply holding the UK top top 100 with quarterly changes. Certainly it's less than holding an active fund and while I haven't hunted, I don't think other managers would be able to offer an OEIC any cheaper really.

The logic that says to use active funds for smallcaps is due to the value of research in exploiting market imperfections relatively more easily compared to the world of largecaps, and is probably more of use when you stray outside the NYSE/NASDAQ or into the smaller unloved areas which can take time to identify and unlock but ultimately elicit the best returns. When markets are up and everything is making money, an index of popular stocks is a good thing to ride. But over a few economic cycles I feel you'll do better with active managers who know their areas. However the issue in doing that, is that it is presumably pretty difficult for a research team to be investigating the smallest companies across the entire planet and consistently get it right.

So, while there are some global smallcap funds that have done OK, I tend to think you would do better having separate money with separate regional specialists. E.g. US smallcaps, UK / European smallcaps, Japanese smallcaps, Asian ex-Japan or emerging smallcaps, etc. Most managers are not going to be masters of everything across the whole world at once without a lot of luck. So, while I think knowing your own local market and beating the local smallcap index is possible, spreading your resources more thinly to try to take on the world is harder. Linton's point there is sound.

If your portfolio is not so big that you can justify having 3 or 4 smallcap funds in it, which many people's aren't, I expect the Vanguard global tracker, or just one active fund whether focussed at home or focussed abroad, will do fine. At the end of the day, it's the asset classes you pick which drive your overall returns more strongly than the specific fund choices in each sector.

Sounds like the purpose of you buying the fund is to patch a perceived hole in the VLS product which is largecap driven. If you don't like the geography or industry mix very much, hold something else to balance it. But adding this fund or that fund will change your overall portfolio mix away from the core VLS holdings and if you don't have a clear goal on what you are investing in and why, best not to tinker too much.

You describe yourself as having "a small amount of money" in an S&S ISA. Perhaps you have £5000 which represents £4000 of global largecap equities (biased to UK) and £1000 of corporate / government bonds (biased to UK). If you add £500 in smallcaps, whether the specific smallcap fund choice delivered +30% or +40% over the next year, or -30% or -40%, the performance differential in actual pounds between the smallcap funds on those figures is only £50 or so, while the difference between your smallcaps and your bonds will probably be much more significant and the smallcaps should not be the dominant holdings in your portfolio unless you are a risktaker.

So I wouldn't get too hung up about it.

System

Thanks for your replies and for a comprehensive reply bowlhead as ever!

Yes your logic is sound and tend to agree about regionally focussed funds being the better option over globally focussed. If I had a large pot invested this would be the way to go, but the amount I have invested wouldn't allow me to do this unless I was putting £500 each into funds, which doesn't seem worth the effort.

I think overall what I am probably subconsciously asking is that for the amount of money I have invested (6k - sorry forgot to mention), is this something I should even be worried about or wait until holdings grow to a sufficient level (say 20k plus??) before thinking about adding on satellite funds?

bowlhead99

If you are OK with having £6k of funds which are £1k bonds, £4k largecaps £1k smallcaps, then sure, add a satellite fund.

It means that instead of having 20% bonds you now only have 16.7% bonds, which is a riskier or more volatile choice.

It also means that instead of having 100% of your equities in global largecaps you have only 80% in global largecaps and 20% in global smallcaps. Again this is a riskier and more volatile choice.

You might be perfectly satisfied with that new mix, more so than you were with the old mix which did not have any smallcaps at all. There is no rule that says you should not change the mix of your portfolio to give a greater focus on a more aggressive mix of equities, when you know what you are doing and are comfortable with the outcome. You do not have to wait until £20k.

However, you may find that the change in returns or risk profile does not excite you enough at low levels of investment because it is still not a lot of return in pounds per year. The worst reaction you could have in consequence to that would be to add more and more 'sexy' funds 'for a bit of spice' and well over-risk yourself.

The changes in a portfolio from adding risk and volatility can go somewhat under the radar, at low investment values, particularly in the conditions we have seen for the last few years when markets were broadly positive. So it's unlikely that making a change will make an appreciable difference to the amount of time it actually takes you to build your £5k portfolio into a £20k one.

However, this can make such 'portfolio tweaks' quite dangerous when things tip back the other way. At £20k-£50k+ you will see rather more of an impact from your activities. I would say the reason most people should not make their small portfolios needlessly complicated is that it is difficult to see the true consequences of the changes they are making, meaning they may be storing up a problem of 'over-risking' which bites them later and they are not actually feeling much benefit in cold hard pounds, for this extra risk.

So, the KISS approach works fine at small levels of investment and you can save the satellite funds for later.

If you want to do some changes and treat them as a learning experience, that's absolutely fine, but just be aware there is not too much to learn when there's only £500-1000 at stake. As a consequence you will either make a little bit of extra money, and think you know it all... or you will lose a bit of money and think it doesn't matter because it's not much and obviously you would have planned better if there was more at stake... so any 'learnings' may be quite superficial.

Good luck with it anyway, I don't wish to put you off. There is no point trying to mirror a £500,000 portfolio with a £5000 one because the individual holdings will be way too small and inefficient to hold. But there is no problem with borrowing ideas from what you would do if you had more money, and using them now.

masonic

teepee83 wrote: »

I think overall what I am probably subconsciously asking is that for the amount of money I have invested (6k - sorry forgot to mention), is this something I should even be worried about or wait until holdings grow to a sufficient level (say 20k plus??) before thinking about adding on satellite funds?

That really depends on the practicalities on your platform. Assuming you are using open ended funds with no dealing charge, then you are only limited by the minimum investment your platform would allow. If you were going for Investment Trusts, then it would be more costly to add them.

System

masonic wrote: »

That really depends on the practicalities on your platform. Assuming you are using open ended funds with no dealing charge, then you are only limited by the minimum investment your platform would allow. If you were going for Investment Trusts, then it would be more costly to add them.

Yes only hold OEICs, on CSD so no dealing charges so in practical terms it wont cost me more, but just more of a question if its worth holding £500 in a fund as a +/- 50% swing wont make much difference financially or mentally on the outcome. Although of course I will be drip feeding so over time the amounts will increase.

System

bowlhead99 wrote: »

If you are OK with having £6k of funds which are £1k bonds, £4k largecaps £1k smallcaps, then sure, add a satellite fund.

It means that instead of having 20% bonds you now only have 16.7% bonds, which is a riskier or more volatile choice.

It also means that instead of having 100% of your equities in global largecaps you have only 80% in global largecaps and 20% in global smallcaps. Again this is a riskier and more volatile choice.

You might be perfectly satisfied with that new mix, more so than you were with the old mix which did not have any smallcaps at all. There is no rule that says you should not change the mix of your portfolio to give a greater focus on a more aggressive mix of equities, when you know what you are doing and are comfortable with the outcome. You do not have to wait until £20k.

However, you may find that the change in returns or risk profile does not excite you enough at low levels of investment because it is still not a lot of return in pounds per year. The worst reaction you could have in consequence to that would be to add more and more 'sexy' funds 'for a bit of spice' and well over-risk yourself.

The changes in a portfolio from adding risk and volatility can go somewhat under the radar, at low investment values, particularly in the conditions we have seen for the last few years when markets were broadly positive. So it's unlikely that making a change will make an appreciable difference to the amount of time it actually takes you to build your £5k portfolio into a £20k one.

However, this can make such 'portfolio tweaks' quite dangerous when things tip back the other way. At £20k-£50k+ you will see rather more of an impact from your activities. I would say the reason most people should not make their small portfolios needlessly complicated is that it is difficult to see the true consequences of the changes they are making, meaning they may be storing up a problem of 'over-risking' which bites them later and they are not actually feeling much benefit in cold hard pounds, for this extra risk.

So, the KISS approach works fine at small levels of investment and you can save the satellite funds for later.

If you want to do some changes and treat them as a learning experience, that's absolutely fine, but just be aware there is not too much to learn when there's only £500-1000 at stake. As a consequence you will either make a little bit of extra money, and think you know it all... or you will lose a bit of money and think it doesn't matter because it's not much and obviously you would have planned better if there was more at stake... so any 'learnings' may be quite superficial.

Good luck with it anyway, I don't wish to put you off. There is no point trying to mirror a £500,000 portfolio with a £5000 one because the individual holdings will be way too small and inefficient to hold. But there is no problem with borrowing ideas from what you would do if you had more money, and using them now.

Thanks and don't worry I wont be put off. I've had my dad encouraging me to invest for years and have seen the results in his investments (and his investments were average-poor performers). One thing I do have on my side is time so volatility is not a concern - in fact I have been thinking about getting rid of the bond component all together at this time due to small amounts invested and prospects for fixed interest over the next few years. Obviously as the years pass by that will change.

Thanks for your input.

masonic

teepee83 wrote: »

Yes only hold OEICs, on CSD so no dealing charges so in practical terms it wont cost me more, but just more of a question if its worth holding £500 in a fund as a +/- 50% swing wont make much difference financially or mentally on the outcome. Although of course I will be drip feeding so over time the amounts will increase.

£500 would be a little under 10% of your portfolio, so would not make a very significant difference. I hold considerably more in smaller companies in my portfolio. Of course, if you meant you would hold £500 per fund and overall hold 3 or more geographic funds, then I'd think you could see a meaningful difference to the outcome.