How to profit from smaller company shares but take less risk

Smaller company shares have delivered the best long-term returns, research shows, but investors must be prepared for volatility along the way.

Research by Paul Marsh and Scott Evans of the London Business School showed that a £1 investment in the Numis Small Companies Index at its starting point in 1955 would have been worth £6,417 by the end of 2018, with dividends reinvested.  

The same investment in the FTSE All-Share would have yielded just £991.

But while the FTSE All-Share delivered a total return of minus 9.5 per cent last year, the small cap index lost 11 per cent.

There will be many investors who saw small caps in their portfolios lose far more than that, with bad news regularly rewarded by 20 to 30 per cent drops in share prices.

So how can you sift through the small companies to find the gems and cut the chance of things going wrong

Top fund manager, Gresham House's Ken Wotton's micro-cap fund fell just 1.3 per cent last year compared to the average fund's 8.8 per cent decline and has delivered a total return of 66.5 per cent over five years compared to the average fund's 41 per cent. He explains how he finds the best small cap shares and reduces risk.