The Investment Column: Small-cap index

THE FTSE small-cap index has enjoyed quite a run - rising 30 per cent in the year to date - but recent interest rate rises have seen its performance against the FTSE 100 go into reverse.

David Rough, the leading City fund manager who heads the investment team at Legal & General, yesterday outlined his thesis that the index is likely to tread water until after the millennium. This should not deter retail investors.

Smaller companies suffered a sell-off last year following the emerging market meltdown, in particular the crisis in Russia. They are perceived as the companies least able to survive an economic slowdown. The sector's recent hammering follows UK interest rate rises, which maintain the pound's strength. British smaller companies are perceived to be exporting manufacturers, which benefit from a weaker pound.

Many companies in the index are also thought to be more vulnerable to the millennium bug, again because they tend to be manufacturers and their IT departments have less spending power. The bull case, says Mr Rough, is that the sector will be set alight should sterling weaken against the euro. And on earnings forecasts, the small-cap index is looking good value. Even so, L&G's funds are only 1.5 per cent overweight in the sector because the interest rate trend is upwards.

There are, however, opportunities for the private investor. Institutional neglect of small-cap stocks - there is little research on companies valued at less than pounds 70m - means there are potentially many bargains around. Investors with the time to conduct some research into stocks with growth potential, such as technology companies, or those they are familiar with, could find themselves with another ARM Holdings on their hands.