Most investors understand what equities and bonds are, as well as understanding the importance of globally diversifying your investments. However, it is also vital to understand that there is a multitude of other factors that need to be considered when building your investment portfolio.
Below, we explain the differences between the different market caps, as well as offering some tips for incorporating the shares into your portfolio.
Large cap companies, as their name suggests, are the biggest companies in the world. These tend to be companies that dominate global markets and account for at least 70% of any domestic stock market.
In the UK, large cap companies are the ones listed on the FTSE 100, covering around 80% of the UK market. Companies in the FTSE 100 include:
- Associated British Foods, which owns food brands such as Twinings, Jordans, Ryvita, and Kingsmill.
- Telecoms companies such as BT and Vodafone
- Retailers Tesco, Sainsburys, and Next
- Oil companies BP and Royal Dutch Shell
- House builders such as Barratt and Persimmon
- Financial companies including NatWest, Barclays, HSBC, and Lloyds
The companies are large and financially stable and will often produce dividend income. However, as the companies are already so large, there is little scope for growth.
As with any investment, there is the risk that major events can swing the entire share price and that their share price can experience volatility. With large cap companies there is the added risk that, due to their sheer size, if the company drops in value or fails altogether, it can skew the whole index and have a rippling effect throughout the entire market.
The next tier of the market, which forms approximately 15% of domestic stock markets, are mid cap companies.
In the UK, mid cap companies tend to sit within the FTSE 250 index. Some of the household names that are within the mid cap sector include: Aston Martin, Currys, Domino’s and Marks & Spencer. Despite still being household names, there is a significant jump from the FTSE 250 to the FTSE 100 and being thought of as a large cap company.
The FTSE 250 also includes a number of investment trusts. These are listed companies which are set up to invest in other companies. They may include some private equity and might even borrow to buy assets. Investment trusts provide more diversification than investing directly in individual companies, and you are also benefitting from investing in a fund manager’s stock-picking expertise.
Mid cap shares are generally more volatile and more sensitive to market events than large cap shares. However, they can offer higher growth potential whilst still investing in a well-known business.
Small cap refers to smaller companies, which collectively account for around 3% of the UK market. UK companies in this category are listed on the FTSE Small Cap index.
Many of the companies on this index are investment trusts, however it does include some well-known names such as:
- Card Factory
- DFS Furniture
- Ted Baker
Small cap companies tend to be much more volatile than larger companies, and they are also less likely to produce strong dividends. There is, however, a significant growth potential due to their size meaning that there is significant scope for growth and expansion.
Collectively, the FTSE 100, FTSE 250, and FTSE Small Cap make up the FTSE All Share index, which represents the vast majority of the UK listed equity market.
The smallest section of the market is held by micro cap companies. In the UK, this is represented by the FTSE Fledgling index.
Again, investment trusts are heavily represented on this index. A few familiar companies on the list are:
- Associated British Engineering
- McColl’s Retail Group
- The Works
Within the universe of listed plcs, this section of the market is likely to be considerably more volatile, but with high growth potential.
How to Decide What to Invest In
There are a number of ways in which you can incorporate different-sized companies into your portfolio. For example:
- You could choose the stocks yourself, however this can be time consuming and you may not have the confidence or expertise to regularly choose reliable investments. Despite this, this is an easy and low-cost option which can be done via trading platforms.
- Another option is by investing in a range of tracker funds. Several investment companies offer low cost trackers which aim to replicate the holdings and performance of the main indices. This is a great way to capture market returns at a reasonable cost, without too much active involvement.
- Actively managed funds is another option easily available. These may specialise in a particular sector of the market, or they could have a multi-asset strategy. This allows you to invest in a diverse range of assets which are selected by an expert fund manager. Active funds are generally more expensive than passive trackers, and do not always outperform them.
- You could delegate the running of your portfolio to an investment manager, who will select funds and shares on your behalf. This offers the most bespoke approach, and is, of course, the most expensive option.
As to what is the best option for you, this will depend on a variety of factors including; the amount you wish to invest, your previous investment experience and the amount of involvement you wish to have with your investments.
As well as selecting different-sized companies, you should also diversify your portfolio in terms of asset class, geographical region, and business sector. This helps to smooth out some of the volatility, as not all of your investments will behave in the same way at the same time.
The construction of your portfolio should also take into account how much risk you are prepared to take. If you need access to your money in a fairly short timeframe, or are nervous about market fluctuations, you should probably invest in less risky assets, such as cash, bonds, and a few mainstream equity funds.
On the other hand, if you are a more adventurous investor with a longer timeframe you may want to maximise your equity content, including smaller company shares, emerging market investments, and alternative assets.
If you would like to discuss your options further, then please do not hesitate to contact a member of the team.