Why NFU Mutual is investing in small cap equities

Matthew Grimson, Fund Manager at NFU Mutual, explains why the insurer is targeting small cap equities and how the asset class fits into the wider investment strategy

Sara Benwellposted on Monday, November 22, 2021

Matthew Grimson, Fund Manager at NFU Mutual

Sara: Benwell: Why is NFU Mutual investing in small cap equities, and what percentage of your overall allocation is in this asset class?

Matthew Grimson: The principle reason to invest in smaller UK companies is the superior total returns historically compared to large companies. There are many reasons why this is the case. Firstly, smaller companies are often growing faster than their larger counterparts.

They are investing more capital back into the business relative to their size and this contributes in superior long-term returns. Furthermore, smaller companies are more frequently the subject of takeover bids from larger and private companies.

“We believe an allocation to Small Cap equity will continue to provide strong and differentiated returns within multi-asset portfolios”

NFU Mutual’s holdings in smaller companies are woven into both our institutional investments and our retail mixed funds as part of a balanced and diversified overall portfolio. Allocations to various assets will vary over time depending on the economic environment, we believe an allocation to Small Cap equity will continue to provide strong and differentiated returns within multi-asset portfolios.

NFU Mutual has a long history of successful investment in and engagement with UK companies and we believe we are able to utilise this experience and have an influence on the Small Cap space.

Sara: How does this fit into NFU Mutual’s wider insurance investment strategy?

Matthew: NFU Mutual was founded in 1910 and has a proud history of investing in the UK economy and in UK businesses. We invest for the long-term for the benefit of our members and investing in smaller UK companies is part of a wider strategy that delivers that long-term sustainable growth.

We also offer our members a wide range of investment products, including pensions and ISAs. Our investments in smaller companies are included in the mixed funds we offer to customers. Holding many different types of assets (Equities, Fixed Interest, Deposits etc.) gives the investor the benefits of diversification.

Holding things that are not perfectly correlated helps to mitigate risk and avoid the pitfalls associated with ‘putting all your eggs in one basket’. UK Smaller Companies are not perfectly correlated with other assets held within our retail portfolios and therefore fortify the benefits of diversification.

Sara: What are the benefits of small caps for insurance investors, and how does the return profile match your needs?

Matthew: The key benefit to investing in smaller UK companies is the return observed for many decades.

Had you put £1 in the Numis Smaller Companies Index (excluding Investment Trusts) on the day of inception in 1955 on January 1st 2021 your investment would be worth £21,186; investing in Numis Large Cap Index over the same time period would have earned you £1,031.

The relative rewards of investing in UK Smaller Companies are potentially huge. However, with return also comes risk.  Smaller companies are often considered among the most risky assets and can be volatile, particularly in the short-term.

“Smaller companies are often considered among the most risky assets and can be volatile”

If UK equity markets are doing well, smaller companies are often doing even better but if equity markets are poor smaller companies are often observed to be worse.

The favourable long term returns of smaller companies are an attractive tool to augment our internal and retail portfolios alike. The key is to hold them as part of a balance and diversified portfolio and invest for the long term.

These benefits are best realised by choosing a good Small Cap manager. NFU Mutual have always had a strong relationship with our Smaller Companies and have the experience and patience to take the genuinely long term view that is required.

Sara: As insurers continue to grapple with low interest rates do small caps provide opportunities in the hunt for yield?

Matthew:  Low interest rates have many ramifications for insurance companies, institutions and private individuals alike. Those with savings in the UK have experienced an interest rate on cash deposits close to zero since the financial crisis in 2008.

Investing in assets, including Smaller Companies, has proven to be a very lucrative alternative to low interest rates over that timeframe.

It is thanks to low interest rates in part that smaller companies have enjoyed such a buoyant decade. Firstly, the lack of return in the low yield world has increased the demand for other assets, such as equities.

Secondly, the low interest rate environment has reduced the cost of capital that smaller companies are faced with. This means that they have been able to invest more over a number of years to fuel long-term growth.

Sara: How are you thinking about ESG within your small caps allocation?

Matthew: ESG is a central tenet to any investment decision taken at NFU Mutual, regardless of asset class or size. However, the key advantage within the small cap world is the dynamic between investor and company affords the investor more influence.

Within our Smaller Companies holdings, it is not unusual for us to find ourselves among the largest owners on the shareholders’ register. We speak privately to the executive teams of our Smaller Companies holdings on a regular basis and therefore have a chance to express our views very strongly.

“There is arguably nowhere in which we can have a bigger impact in this endeavour than UK Smaller Companies.”

We can use our increased influence as a force for good in this relationship. As a louder voice around the table we can actively encourage companies to improve their practices.

Investing in companies that have strong ESG practices is prudent and, in our opinion, will add value over the long term. However, the journey shouldn’t be a passive one. As investors, we must use our influence to enhance governance standards, to make companies more socially progressive and to push the transition to more environmentally sustainable operations.

There is arguably nowhere in which we can have a bigger impact in this endeavour than UK Smaller Companies.

 

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