RBS is readying a small cap index tracker.
Wishing for a time machine to take you back to invest £1,000 in the Hoare Govett Smaller Companies index (HGSC) has become something of an annual event for those who follow the tinier end of the stock market.
That's because every January, London Business School professors Elroy Dimson and Paul Marsh reveal their latest analysis of both the short and long-term returns of the HGSC index, which is effectively the UK's small cap benchmark.
This year's findings were as jaw dropping as ever. The pair found that if you'd put £1,000 into the HGSC index in 1955 and then reinvested your dividends thereafter, by the end of 2010 you'd have a pot worth £3.25 million.
That smashed the returns from the wider FTSE All-Share by 3.4% a year; playing safe and investing £1,000 then reinvesting dividends into the All-Share instead would have delivered just £620,000.
Of course, £1,000 was big money in 1955, reinvesting dividends would have cost a bomb in the days before discount brokers, 55 years to 2010 is truly a long time -- and you might have wanted to reduce your investment when your £1,000 became six figures, let alone seven.
But there's a more substantial hitch. Even if you could convince Dr Who to take you back to the era of Teddy Boys and safe nuclear power stations to put your money into the HGSC index, you'd have wasted your time trip.
There was no way to invest in the HGSC index back then, not least because while the companies it comprised were obviously trading, the index itself didn't exist in 1955 -- it was developed by the professors in 1987. And two decades before the invention of tracker funds, it wouldn't have been investable, anyway!
Hoary problem
Thank goodness we now have passive tracking funds that make all this a doddle, right?
Well, yes -- except that even today there's no way to track the HGSC index!
This means that unlike US investors, say, who can track their equivalent small cap indexes with the click of a button, UK investors have either had to buy individual small cap shares, or else pay a fund manager to hunt and buy companies for them. A big hit from costs as well as divergent returns from the HGSC index are the inevitable consequence.
But this is finally about to change: Hoare Govett's owner, Royal Bank of Scotland (LSE: RBS) announced this week that it's set to launch exchange traded vehicles that will allow us to track a version of the HGSC index, just like many of us track the FTSE 100 and other major markets.
RBS will first enable HGSC tracking via Exchange Traded Notes (ETN) listed in Frankfurt and London next week. The bank plans to follow this up with an Exchange Traded Fund (ETF) in summer.
A few little niggles
I think this is great news, but there are some wrinkles we need to keep in mind.
First off, these passive products won't track the entire HGSC index. Instead, they'll attempt to deliver the returns, after costs, of a portion of it.
The HGSC Index tracks the smallest 10 per cent of the UK stock market by capitalisation -- 430 companies in total. But the RBS tradable version will only follow the largest and most liquid 200 of them.
Clipping the index like this may be necessary for practical reasons, but it's likely to affect returns. Research from Dimson and Marsh has previously demonstrated it's the smallest companies that have posted the greatest gains.
Then there's the fact you can only invest via ETNs, at least until the planned ETF tracker arrives. Without going into all the ins-and-outs of ETNs, it suffices to say that they're considered riskier than ETFs -- especially the non-collaterised version, which is what RBS plans to offer for the London market.
Lastly, there's no word on charges yet, which are always worth taking into consideration.
Little and large
I certainly don't want to bemoan the arrival of a true UK small cap index tracker. On the contrary, I think our investing scene is crying out for one.
I'm also hopeful that by making it far easier to gain exposure to small caps, these products could encourage more institutional money to be pumped into this end of the market. This could raise depressed valuations, and perhaps even stem the de-listings and cheap takeovers that have dogged the market in recent years.
You only have to look at the impact of passive funds on gold holdings to see the difference such products can make in niche areas.
All that said, it's no great shock these HGSC index tracking products are being readied after a couple of years in which little companies have bested the returns from the FTSE 100. Contrarians will no doubt be loading up on cheap-looking blue chips!
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