INVESTORS in popular smaller-company funds have been warned that the bull market they have enjoyed since the beginning of the decade may be coming to an end.

While the FTSE 100 index of Britain’s largest companies has risen 4.5% over the past three months and 7.5% so far this year, smaller firms are having a harder time. The FTSE 250, which covers the next biggest firms, lost 5.5% of its value in June, and has fallen 0.4% over the last quarter, although it is still up 6.2% this year.

This is a reversal of a trend that has held sway since the turn of the century, which has seen blue chips lag behind their smaller rivals – by 57% over the past seven years, according to research from Lehman Brothers, an investment bank.

Investors have therefore poured money into smaller-company funds and have been richly rewarded with a five-year return of 137% compared with just 85% for funds in the All-Companies sector, which tend to focus on bigger firms.

Analysts have been warning for some time that the tide would turn because blue chips are cheaper relative to smaller firms than they have been for two decades, according to fund manager Invesco Perpetual. Now it seems their predictions could be right: the £500m Schroder UK Mid 250 fund, managed by high-profile manager Andy Brough, is down 2.25% in the past three months, while the popular Standard Life UK Opportunities fund has slipped nearly 4%.

While these are small figures over a short timeframe, analysts say it shows a sea-change that reflects the different make up of the second-tier index. It is more exposed to the UK economy, with a larger proportion of housebuilders and smaller retailers, and has therefore been hit hard by five rises in interest rates since last August.

Clothing retailers have recently reported their worst season for five years, while property shares have plunged 30% since January. Land Securities has had £1.8 billion shaved from its stock-market value, while British Land has lost £1.5 billion.

The Footsie, on the other hand, is crammed with international businesses that are less affected by events in Britain. Only 40% of its sales come from Britain, compared with 54% for the FTSE 250, according to investment bank HSBC.

Robert Parkes, the bank’s UK equity strategist, said: “We think that larger companies will be a better bet going forward, and that the outperformance of medium-sized companies is coming to an end. It is telling that mergers and acquisitions activity has moved from the second liners to the FTSE 100.”

Advisers therefore say now is not the time to be buying a smaller-company fund, although existing investors should stay put. Justin Modray at Bestinvest, an independent adviser, said: “The consensus is that large caps are likely to do better than mid and small caps in the near future, so it is probably the wrong time to invest in a mid-cap fund based on strong performance in recent years.”

Conversely, now could be one of the best times in years to pick up world-beating Footsie names, many of which are cheaper than in the depths of the bear market in 2003. Footsie shares are now trading at 12.5 time earnings, compared with a price/ earnings ratio of 19.1 for the FTSE Mid 250 and 25 for the FTSE Small Cap, according to Stanhope Capital.

Many smaller-company managers are moving into the market’s biggest names to try to stem their underperformance. RichardBuxton, manager of Schroder UK Alpha Plus, typically has 25% in smaller firms but has cut that to about 15% in the past six months.

He said: “There are particularly interesting opportunities in the mega caps at the moment – the very biggest Footsie firms. In valuation terms, they are cheaper now than they were during the bear market. When I launched the Alpha Plus fund five years ago, I bought some Glaxo Smith Kline shares for about the same as they cost now.”

If you want to profit from a change in fortunes for the Footsie, Modray recommends a tracker or exchange-traded fund, rather than an actively managed scheme because most large-company managers struggle to beat the index. He suggests Fidelity Mon-eybuilder UK Index, which has an annual fee of 0.3%, or I-shares FTSE 100 with a 0.4% annual charge Another option is to go for a fund where the manager has the remit to invest in companies of different sizes, such as Schroder UK Alpha Plus and Merrill Lynch UK Special Situations.

Some managers are already starting to buy back into smaller firms. Buxton said: “I don’t think it’s quite the time to go back into housebuilders yet, but I am sneaking back in to some property firms such as British Land.”

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