It is often considered axiomatic in investment markets that smaller companies offer greater pricing inefficiencies, and thus greater opportunities to active managers to generate outperformance. In the UK Small Cap space, we have certainly seen suggestions over the long term that this is true, with the Morningstar UK Small Cap sector producing an average NAV return of c. 173.4% over the ten years to 05/02/2021, compared to a return of c. 115.2% from the Numis Small Cap including AIM excluding Investment Companies Index. Yet in more recent months the average active strategy has notably lagged a strong rally in the Numis index, albeit they have produced strong absolute returns themselves. That this has coincided with a strong period of performance in mining companies is, we think, no coincidence. In the current environment, we think this is relevant, and a pattern that is likely to continue to hold. Shareholders in UK small cap trusts should, if anything, be reassured if it does. Below we explain why, and review both the case for mining stocks and UK small caps. Before we go any further, let us clearly set out our stall: we are positive on the relative prospects for UK small cap equities, and for mining equities. We do not believe, by any manner of means, that this is an either/or allocation decision, especially when we look at historic correlations (the Numis index has a ten-year median R2 of 0.34 to BRWM). So, we believe investors are well-advised to consider holding exposure to both asset classes at this time. Nonetheless, investors in UK small cap trusts should accept that a concurrent rally in these assets is likely to prove a headwind to relative returns for actively managed small cap strategies. Conversely to what may be an instinctive reaction to this, we think shareholders should welcome this if a commodity rally does result in it becoming harder for active managers to outperform.
