COLIN McLEAN

Is it still worthwhile to pick individual shares? Private investors seem to be at a disadvantage to the professionals in stockmarket investment. But there may be ways they can tilt the odds – giving them a chance of not only beating the market, but also outperforming the biggest institutions. That sounds challenging, but the data seems to support stockpicking provided it is very focused. It is not a guarantee against losses, and depends on having a spread of investments in a portfolio, as well as patience.

Recent years have seen strong performance in medium sized companies, those in the FTSE Mid 250 Index. These 250 companies range in size from a value of £500m to £5bn – with the shares at the top end considered for promotion into the FTSE 100 Index. They tend to be less well researched. Fewer stockbrokers interested in analysing them means a greater chance that the shares will be mispriced. For investors looking for undervalued businesses, this area typically gives better prospects than the very biggest FTSE 100 companies. Despite the number of medium sized businesses, for the biggest investment banks and institutions, the area is under the radar. In fact, the largest three companies listed on the London market – Royal Dutch Shell, HSBC and British American Tobacco – add up to more than the combined value of all 250 mid cap businesses.

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Also of interest to stockpickers are the largest companies listed on the Alternative Investment Market (AIM), an area of lighter regulation and more risk, but nevertheless containing some recent stockmarket winners. Online retailer, ASOS and mixer drinks group, Fevertree are in this category. With limited additional capital needs, they are in no rush for promotion onto the main stockmarket.

Conventional wisdom is that the popular index funds pile into the biggest companies and that blue-chips are inherently safer, but the facts will surprise many. Over periods of three years and more, up to the entire 30 year life of the FTSE Mid 250 Index, medium sized companies have tended to outperform the very biggest. And, even taking risk and volatility into account, the extra reward is still attractive. It seems to go against the grain – surely such an obvious opportunity would be quickly competed away by all the big smart institutional investors?

The clue to the challenge is in the size of the opportunity and the nature of these businesses. Many insurance and pension funds are very large and would find it hard to build up meaningful holdings in these companies. Opportunities only tend to come along when companies raise new money. But, many of these businesses, including ASOS and Fevertree, have structured themselves to make much less use of external capital. This has allowed their businesses to be quickly scalable, as has been seen in Fevertree’s rapid ascent. This is a key characteristic of disruptive businesses, which must move quickly as they enter a new area, taking business from a longstanding incumbent.

After initial listing, these companies offer less opportunity for institutional entry. Bigger institutions trying to buy in the stockmarket can quickly push up the price, but this is not a problem for private investors and many unit trusts. The average unit trust picking shares across the whole range of the FTSE All-Share Index, and not confined to the biggest companies, has outperformed over similar periods to the FTSE Mid 250. The anomaly is not a secret, but clearly only useful for private investors and some unit trusts.

The tailwinds for medium sized companies and some of those listed on AIM, are inclusion of more technology and high growth businesses. Some of these are disrupting much bigger businesses, undermining long-standing brands and services. In this turbulent environment, the biggest global businesses are no longer safe. For example, recently Heinz has reported sharp falls in sales of some of its long-standing food brands. The biggest listed companies – oil, mining, banks, pharmaceuticals and tobacco – tend to be driven by the global economy but at risk from trade frictions and currency volatility.

Certainly, index investing and ETFs can lower cost. But, for private investors with the confidence to pick shares, the odds may be in their favour.

Colin McLean is managing director of SVM Asset Management.