Something Asset Allocator has picked up on recently from some DFMs is a growing interest in smaller companies.

First, Abrdn picked up a few funds for use within their MPS in March, then Albert E Sharp told us they’re looking to reinvest their cash pile into smaller companies once interest rate cuts begin to take form.

Albert E Sharp’s head of MPS James Crocker told us he also believes the conventional wisdom of small-cap outperformance after a recession is an incredibly persuasive argument.

Not to mention last week we reported Quilter Cheviot initiated a position in US small-caps for the first time, indicating that a similar rate environment across the pond could also be beneficial for this region, too. 

Indeed our most recent DFM pulse check showed that 70 per cent of allocators view smaller companies positively – the highest of any asset class at present.

And so with all this in mind we sought to ascertain which funds comprise the most popular domestic small-cap mandates in our database, and the results are certainly worth considering. 

Before we begin, however, it’s worth bearing in mind that not all DFMs allot a defined weighting to UK smaller companies, and the overall average allocation to such funds hovers between one and two per cent. 

Most DFMs choose just one fund to capture exposure to this asset class, so which ones get the nod? 

One thing which is clear is that when it comes to UK smaller companies, allocators prefer funds which are run by, well, smaller companies with Chelverton, Gresham House and Tellworth all winning out (the last of these is now part of Premier Miton - though that still makes it hardly a fund giant). 

Montanaro, Teviot Partners and Whitman Asset Management all get a nod as well.

But the clear winner here is Chelverton UK Equity Growth, held by five allocators. This is followed by Tellworth UK Smaller Companies with three. 

But after that, the options diverge significantly, and it really comes down to personal preference. 

While both Gresham House Smaller Companies and Fidelity UK Smaller Companies are held by two DFMs, the remaining 12 funds on the database are held by one allocator apiece, indicating a diversity of opinion as to the preferred mandate lower down the market-cap scale. 

Other one-hit wonders include mandates by Jupiter, BlackRock, and Dimensional, to name but three.

There are absolutely no passive plays in the UK smaller companies market - unlike in the US market where there are plenty.

And most of the funds held have what Morningstar calls a blended style - ie neither value nor growth. Which is perhaps appropriate given we are talking about the growthier end of a very value market.

It may seem somewhat counterintuitive to even consider past performance in an asset class that’s been so out of favour, but Chelverton has excelled in the space, returning 14 per cent over one year and 50 per cent over five.

For now, it seems that some DFMs see the forthcoming macroeconomic environment as facilitating more favourable conditions for such firms to recover, in particular once the cost of borrowing eventually wanes. 

“The case for small caps to rally going into a recovery, I think, is extremely persuasive and totally stands to reason as to why as the economic conditions deteriorate, small caps generally feel the pain first,” said Crocker. 

“It comes out in the financial results and the share prices suffer. But as interest rates get cut, as conditions improve. On the other side of the coin, you suddenly see their financial performance improve, and they're often the first to feel it and that therefore feeds into the share price.”