Personal Finance: Brian Tora's column

It is disconcerting when, because of limited marketability, the shares you hold are unsaleable

BEFORE I went on holiday some weeks ago, I promised to return to the topic of smaller companies. This was suddenly brought to my mind again when, at our annual investment seminar in the City of London, nearly half the questions put to speakers related to smaller companies. It seems that everyone has the enthusiasm to buy them, but no one is actually putting money where their mouths are.

Strictly speaking that is not true. Smaller companies are beginning to attract a little more interest. Not only has their under-performance been reversed a little, but a new index has been created to track them. This could be useful, given the growing popularity of indexation as a means of investing.

The bear market in smaller companies is not purely a UK phenomenon. In America, investors have been eschewing small-market capitalisation stocks for a considerable period. The result has been a divide in valuation levels between large and small companies that has grown to significant proportions.

In the US, the reasons were not difficult to fathom. The growing popularity of indexation and quantitative investment techniques created a demand for the larger companies making up the indices being tracked by investors. Also, the sums involved for US investment houses demanded liquidity that smaller companies could not deliver.

These factors have influenced demand for smaller company shares in the UK, but there has been an additional reason, not so relevant in America. The US economy is more self-sufficient than ours, but many UK smaller companies, particularly in manufacturing, were adversely affected by the strength of sterling. In other words, there seemed good fundamental reasons for avoiding the smaller cap stocks as well as the technical driving forces that existed.

Has the situation changed? I think it may have done. Sterling is not as strong as it was and economists are beginning to veer to the conclusion that the euro could be a strong currency after all. An improved competitive edge would help many of Britain's smaller businesses, while the very much better returns available from smaller companies, particularly in terms of the dividend yield, will attract some investors now that returns on bonds have dropped so far. Indeed, one investment management house announced recently that it was switching from fixed interest securities to smaller companies for one of its income funds.

The trouble with smaller company shares is that they are likely to be much more volatile. It is disconcerting when, because of limited marketability, the shares you hold are unsaleable. Perhaps the answer is a fund of smaller company shares. It seems I am only beginning to scratch the surface. Watch this space!

Brian Tora is chairman of the Greig Middleton investment strategy committee