Smaller companies in the UK enjoyed an exceptional run in the years after the 2008 financial crisis, faring particularly well in 2012/13. However, they paused for breath in the second half of 2014, giving back some of their gains, while larger companies, particularly pharmaceuticals, started to outperform.
The smaller company sell-off became more pronounced as investors following momentum strategies (investing in whatever areas are performing well and quickly disposing of anything falling in value) exited the sector. While this approach sounds fine in practice, it can rack up dealing costs. I firmly believe masterly inactivity is often the best policy, and prefer to buy and hold investments for the long term.
At a time when so many investors are concentrating on wider issues, such as China, the Greek debt crisis and the prospect of rising interest rates, I prefer to step back and take stock of what is happening to individual companies.
As such, when I met manager of Standard Life UK Smaller Companies Harry Nimmo recently, I was interested in getting a feel for his fund’s underlying holdings.
Nimmo seeks to identify tomorrow’s giants today and shares my long-term buy and hold view. Unlike many other smaller company fund managers, he tends to ride his winners as they progress to the FTSE 100. He then uses these companies as a source of easily accessible cash, gradually reducing the holdings and recycling the proceeds into new opportunities.
I am encouraged by the high number of the fund’s holdings reporting results ahead of expectations: Rightmove, JD Sports, Greggs and Fever Tree to name a few. The latter, a premium mixer drinks company, has performed particularly well. It has benefited from the emergence of a vibrant gin market and Nimmo was keen to emphasise that the management team remain excited about the company’s future prospects. Positive trading language is frequently combined with strong dividend growth, which bodes well for the future prospects of these holdings, in his view.
It is important to understand a manager’s style of investing and the sort of stocks their process leads them to. Nimmo seeks companies that are capable of strong growth with robust balance sheets and visible earnings growth. There will be times, as illustrated by certain points over the past five years, when investors favour more economically sensitive, undervalued companies, or those that have been through a tough time but have recovery prospects. During these times, the type of company Nimmo prefers will find it more difficult to outperform.
However, his disciplined approach stands him in good stead for the long-term. Profitable businesses with recurring revenue streams tend to be more capable of steady growth. The fund is currently tilted towards domestically-oriented sectors, such as retailers, real estate, food and drink, media and financial services, avoiding internationally exposed areas such as mining, oil and gas, and manufacturing.
As 70 per cent of profits generated by the underlying holdings are from the UK, the fund has benefited from the UK’s recent economic strength.
During more turbulent times, I always listen to the view of talented stockpickers. If they are finding few opportunities to invest, I worry. If they are still finding good prospects, I feel more confident about the durability of the market. I have met a number of stock-picking managers over the past few weeks and they are all finding plenty of reasons to part with their cash.
Smaller companies have recovered slightly over the past few months as larger firms, particularly those in the commodity, oil and mining sectors, have suffered falls. As expected, over the long-term, smaller companies have excelled relative to their larger counterparts. I would view any weakness in the space as an opportunity to top up positions at reduced prices.
Mark Dampier is head of research at Hargreaves Lansdown