Investors have continued snubbing UK small company equities despite the strong returns they have generated over the past five years.

Investors have continued snubbing UK small company equities despite the strong returns they have generated over the past five years.

The latest survey from UK fund management company Octopus reveals that 83 per cent of financial advisors are keen on investing in companies listed on the UK’s Alternative Investment Market (AIM) yet appetite among investors remains poor. Just 26 per cent of advisors have seen an increased demand for smaller companies from investors in the last twelve months.

Traditionally investors have viewed small companies as high risk with fears that they could go bust while a lack of liquidity makes them harder to trade on AIM.

Yet data shows that investors who have taken on the risk in the past five years have made healthy returns. Over the past five years the UK smaller companies fund average has returned 190 per cent versus 105 per cent for the FTSE UK equity index. From the end of May last year, the FTSE Small Cap index is up 34.39 per cent, versus FTSE 100 and FTSE All Share returns of 20.82 per cent and 22.46 per cent respectively.

“Smaller companies have been on a great run,” said Darius McDermott, managing director at Chelsea Investment Intelligence. “It’s important to remember that the market was starting at a very low base following the recession and so the companies were lowly valued.”

And the run according to Guy Myles, Octopus co-founder, will keep on rolling for the year ahead. He predicts potential returns for Octopus Investments - a retail fund management company specialising in smaller company investing - could be as high as 20 per cent. The traditional FTSE markets in contrast look to have peaked with single digit growth estimated for 2014.

For some fund managers though the run is already over as small cap stocks now look grossly overvalued and at the same time there are few bargains left in the market. “The stocks aren’t cheap and it’s getting harder and harder to find cheap ones. It’s now an expensive asset class,” McDermott added.

The trend for investors in recent years has been to take money out of UK small cap stocks and move into emerging market equity markets. This trend continues despite UK small cap funds outperforming their counterparts in the IMA Global Emerging Markets sector in the short, medium and long-term, and with less volatility.

The UK smaller companies sector has made 46.58 per cent over the past three years – the figure for the emerging markets sector is just 11.35 per cent, data from FE Analytics reveals. While the average fund in IMA UK Smaller Companies has an annualised volatility of 16.51 per cent over 10 years, compared with 19.12 per cent from IMA Asia Pacific ex Japan, and 20.65 per cent from IMA Global Emerging Markets.

Richard Power, manager of the CF Octopus UK Micro Cap Growth fund, said in January that investors obsessed with the emerging market growth story are missing on higher returns closer to home.

"A lot of money has been sucked out of the IMA UK Smaller Companies sector in recent years. A lot of that is to do with investors looking for growth in emerging markets, when they have a great 'emerging market' on their doorstep," he added.