‘The Future is Small’ (Harriman House, 2014), a newly-published book from Miton Asset Management’s Gervais Williams, contends that while returns from large-cap stocks will remain low in an environment without decent economic growth, we are at the early stages of a multi-decade period of small-company outperformance.

Gervais describes the period since the 1980s as one of unprecedented credit expansion leading to asset price inflation on a tremendous scale and an “abundance of speculative, secured investment where the capital borrowed can only be repaid if asset prices keep rising”. Avoiding the depression that should follow when such speculative bubbles burst has been the objective of central banks since 2008.

Williams notes that smaller companies got left out of that 30-year credit boom and its accompanying development of corporate debt markets, which saw the banking sector focus on larger clients and centralise their lending decisions. “Perversely, in the midst of a credit boom, many smaller quoted companies found their access to credit increasingly constrained,” he writes. At the same time institutional investment has gravitated towards larger companies as portfolios have internationalised in response to globalisation – pension funds have been selling domestic small-caps in exchange for multinational large-caps. 

But Williams argues that now that we are entering a period of lower international growth rates, investors need to reassess how the growth characteristics of large and small companies differ. 

Williams’ argument for the coming small-cap outperformance is not about the small-cap effect described by academics. Instead, he emphasises that while both large and small companies can expand during times of plenty, when economic growth is sluggish firms with major market positions tend, by definition, to struggle to achieve earnings growth. In contrast, there is always a proportion of smaller companies with smaller market positions that find ways to sustain growth momentum. 

Unfortunately, the final third of Williams’ book dedicates itself to a panegyric of the UK’s Alternative Investment Market (AIM) and in his enthusiasm, readers may feel that he has forgotten to conclude the case for a new “super-cycle” of small company returns. But the idea – that smaller firms can maintain momentum in their fight for a marginally larger share of a non-growing or slow-growing pie – is one that investors should spend some time considering.