Risks can be big in small caps

The rewards for getting calls right on small companies can be big, but so are the dangers of getting them wrong. It is difficult for small investors to get enough diversification, which is where managed funds come in.

The rewards for getting calls right on small companies can be big, but so are the dangers of getting them wrong. It is difficult for small investors to get enough diversification, which is where managed funds come in.

In a report on small-company funds, research company Lonsec says investment in small companies should be only an adjunct to the main exposure in large caps, rather than the sole investment.

That is because of the more-volatile and less-liquid nature of small caps compared with large companies. Smaller businesses also have varying degrees of quality and stages of development.

Fewer small companies are covered by brokers and analysts than large companies.

Lonsec says that creates opportunities for fund managers to find attractive investments before the wider market does.

Small-company fund managers are more likely to outperform the relevant market index, after fees, compared with those who invest in large companies.

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