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Mutual attraction

Most commentators continue to view bigger companies in the UK and around the world as the place to be. Indeed, I include myself in this. The vast majority have become cheaper over the last 10 years and the likes of GlaxoSmithKline, Vodafone (and arguably even BP despite its current problems) do look good value. In particular, their dividend yields are attractive at 5 per cent or more in many cases. They also benefit from deriving much of their earnings from overseas and in currencies other than sterling, notably the US dollar. The increase in these currencies against the pound, which has been comparatively weak over the last couple of years, has enhanced their profits markedly.

By contrast, the general assumption is that smaller companies are domestically oriented and not a good place to invest, given the problems faced by the UK consumer, not to mention the UK government. However, there are always two sides to every story and small company investing has evolved over the last 25 years. At one time it was centred on UK-focused engineering companies in the Midlands and in the North. Things have since changed dramatically, and if we look at the Hoare Govett smaller companies index (which has rallied by around 35 per cent over the last 12 months, outperforming large caps by quite some way) we find around 40 per cent of company earnings are now from outside the UK. So the idea that a UK smaller companies fund only offers domestic exposure is mistaken.

While the FTSE 100 is dominated by relatively few companies, the UK’s smaller firms can also offer important diversification to investors through exposure to a wide range of sectors. Resources, chemicals, consumer goods and technology companies are all areas where overseas exposure can be significant. One smaller companies fund with a large international exposure is the Old Mutual UK select smaller companies.
Under the management of Dan Nickols, it has performed except-ionally well over the past five years increasing by 87 per cent against the sector average of 29 per cent, a strong run that has also easily outstripped bigger company funds.

Although overseas earners offer some good opportunities, Mr Nickols believes there is also plenty of scope in certain domestically oriented stocks which have exposure to long-term growth trends. These include companies such as Rightmove, which has completely changed the way in which people search for properties. He also sees opportunities in engin-eering firms such as Cookson and Weir, where he believes analyst’s forecasts are too pessimistic and he expects to see upgrades in earnings forecasts. Indeed, the fund managers I have spoken to over the last few weeks all report companies performing ahead of expectations, exactly the kind of news you want to hear because this is what tends to drive share prices higher. In terms of present valuations, smaller companies stocks at first glance look more expensive than bigger ones.

However, Mr Nickols expects annual earnings growth to be at least in the mid-teens, which makes the market look pretty cheap to me.

So here we have a fund with a good blend of top domestic stocks alongside plenty of international exposure benefiting from the fall in sterling. Yet smaller companies are often ignored by advisers and investors for reasons I do not really understand. Over the longer term, they tend to outperform larger stocks and offer active fund managers such as Nickols and the team at Old Mutual a chance to add considerable value.

While the headlines in the papers might make you feel somewhat nervous (something I can fully appreciate at the moment), the truth is many companies continue to prosper and generate profits despite what is going on in the global background. The Old Mutual team is second to none in this part of the market and this is an excellent fund to tuck away for the long term.

Mark Dampier is head of research at Hargreaves Lansdown

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