The conventional wisdom among most investors is that owning shares in big companies is less risky than investing in small ones. It seems obvious. Big companies are often well-established, have leading positions in their markets and are financially robust enough to withstand the ups and downs of the business cycle. Small companies tend to be less financially robust, depend on fewer customers and are forced to compete with bigger rivals for market share. Big should equal steady but unspectacular progress, and small should equal more risk but the potential for greater reward if the company can keep growing.
My uncritical acceptance of this idea was the main reason why, when I was thinking about how to create income for our aged mother in order to help meet the costs of her long-term care, having concluded that the likely income from bonds rendered them unsuitable, I concentrated on large company shares as the next best place to go.
I was following a path that pretty much all the investors in the world—DIY and professional—are also treading: accepting greater risk of losing money in order to achieve the level of income required to get by. But as many have discovered, for people with compelling needs and few safe options, the financial world is now a very risky place indeed.
Riskier, in fact, than I understood. FirstGroup, one of the world’s biggest public transport companies and a member of the FTSE 250, suffered nasty losses in 2012, which it is still recovering from, and shareholders are facing a dividend-free period while management picks up the pieces. More recently, shares in RSA, the UK’s second biggest general insurer, fell dramatically because of problems in its Irish business. Again, a supposedly low-risk attempt to generate income ended up looking like a reckless punt, and I can’t help feeling that I have let my mother down.
FirstGroup and RSA were both very large and supposedly stable businesses, providing products and services that millions of people need and will continue to need for years to come—classic “safe bets.” Yet both turned out to be accidents waiting to happen and if you look back over the past few years you can see that they are far from alone.
A frighteningly large number of the UK’s biggest and most established businesses have turned out to be well-concealed sinks of risk. BP went horribly wrong in 2010 thanks to the Deepwater Horizon disaster. Tesco’s invasion of America degenerated into a rout that left it badly exposed at home. The giant outsourcing businesses Capita and Serco both turned out to be far more vulnerable to mishaps than their size would suggest. The big utility companies—archetypal income investments—have been rattled by political bickering over rising fuel bills. And we are where we are today largely because the entire banking industry wasn’t dull and predictable after all.
Given all this, the notion that large companies are somehow less risky than smaller ones needs to be treated with great caution, particularly now that a lot of investors see shares in big companies as a way to generate the income that they used to look for in much safer investments such as bonds.
It’s obvious from looking at a price chart that shares in small companies usually lurch more violently than shares in large companies, and this characteristic is usually taken to signify their relative degrees of risk. Shares in large companies might follow a smoother trajectory on the charts, but this tells us nothing about the risks that lurk in their day-to-day operations, or in the shifting intentions of their regulators and political masters.
Large companies are complex organisations that are very difficult to manage effectively and can prove opaque both to those who invest in them and, more worryingly, to those paid to run them. They can be just as full of risk as small companies, though they are generally better at concealing it.
Andy Davis is an Associate Editor of Prospect
Too big to fail?
January 23, 2014
