Small fry fight back

Quoted smaller companies have not lived up to the promise of the first quarter of last year, when the FT-SE Small Cap index peaked at 2,091. Since then, the index has generally underperformed the rest of the market, which has itself been on a gentle decline.

But recent signs suggest smaller companies could soon be coming back into fashion. The gap with the All Share index has recently been closed, leaving the Small Cap at just above 1,760 standing at a tiny premium. This reflects an improving investment background and better fundamentals.

At least some of the underperformance was due to the priority given by institutions to the record £11.6bn in new issues and £7.1bn in rights calls in 1994. The pressure on funds has eased dramatically in the first quarter, with combined raisings of just £2.3bn paling by comparison.

Reduced pressure on institutional cash comes as many observers believe we may have reached the stage in the economic cycle when increased takeover activity starts recycling cash into the market.

Historic evidence shows also that small firms tend to outperform their bigger brethren later in the cycle.

Meanwhile, the trading prospects remain relatively bright for the sector. Soundings taken among small and medium- sized businesses by 3i's Enterprise Barometer in March showed confidence about the general economic outlook dipping since December, but most smaller firms remaining enthusiastic about their own prospects.

John Houlihan, small companies expert at brokers Hoare Govett, believes the firm's small companies index, currently around 1,461, will be testing 1,700 by the year-end. With the market looking for only a 300-point gain on the Footsie in the same period, that should mean a period of outperformance is in prospect.