For a fund manager whose benchmark index has fallen by 46 per cent during the past 12 months, Harry Nimmo is remarkably chipper. That's because Mr Nimmo, who runs Standard Life's smaller companies unit trust and investment trust, is confident that the worst is behind us and is expecting a major market turn very soon.
"I think the market will potentially turn on 1 December," he says. If so, it would mark an upbeat end to what has been a difficult year. The benchmark Hoare Govett smaller companies index has fallen heavily as the share prices of its constituents - mostly small UK-focused companies that are among the first to suffer in an economic downturn - have been savaged. In that context, Mr Nimmo's funds have performed relatively well. The value of the unit trust has fallen by 36 per cent, outperforming its benchmark by 10 percentage points, while the investment trust is down 27 per cent.
Such outperformance is not unusual for Mr Nimmo, who has been running the unit trust since its inception in 1997. It has beaten the small companies sector average over the past one, two, three, five and 10 years, with an average annual return of 13 per cent.
The strong performance is based on a very specific stock selection process which eschews fads and fashions, and instead relies on screening to highlight the most attractive companies. "I don't try to mirror the benchmark," he says. "I like to own stocks that I like, so there are no passengers."
Past successes
The screening process uses eight criteria - largely based on earnings growth, share price momentum and balance sheet strength - to select what Mr Nimmo refers to as "tomorrow's larger companies today". In that respect, the process has had plenty of success. Past selections include FTSE 100 members Cairn, Sage, Autonomy, Shire and Capita. And once he's found a company that he likes, he's prepared to stick with it. "Turnover of holdings is low," he says. "I own companies for three years or more."
His investment universe comprises anything with a market capitalisation of below £1bn but above £40m. He limits his exposure to Aim to 25 per cent of the portfolio and his exposure to what he calls "concept stocks" to 5 per cent of the portfolio.
That said, he will not stand by if his investments don't work out. "There's a strong element of momentum. I like to run winners and cut losers. And I'm not a value investor in the traditional sense ... I don’t like trying to catch a falling knife."
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Current challenges
But while this disciplined approach has performed well in the past, there are drawbacks. For a start, Mr Nimmo is not the only small cap fund manager who is trying to buy "tomorrow's larger companies today". Small cap companies which demonstrate a combination of earnings growth, cash generation and solid finances are rare, so their shares are not cheap. The average PE of the top 10 stocks in Mr Nimmo's unit trust is a hefty 19.
The other disadvantage is that the portfolio performs relatively badly at certain points in the cycle. For example, the fund does relatively poorly in theme-driven markets, such as the dotcom boom and the recent commodities bull market. And the early stages of a bull market are also relatively poor. "In the initial stages of recovery, we underperform other small company funds because our process is slanted towards high quality companies which underperform in a recovering market," says Mr Nimmo.
But even if the market does recover in 2009, Mr Nimmo will have other things on his mind. Earlier this month, the Standard Life UK Smaller Companies Investment Trust announced a proposal to buy rival Gartmore Smaller Companies Trust. Gartmore had been underperforming for some time and shareholders were starting to get restless. Meanwhile, both trusts are relatively small (Standard Life is worth £28m, while Gartmore is worth £46m) and lack the critical mass needed to be successful. If the proposal is approved by shareholders - and so far 55 per cent of shareholders in the Standard Life Trust and 60 per cent of shareholders in the Gartmore Trust have said that they will support it - the deal will take place in January and will double the size of the Standard Life Trust to around £55m. However, this is not a done deal. A second Gartmore trust, Gartmore Growth Opportunities, has taken an eight per cent stake in its sister trust and could propose a full merger, which would scupper the Standard Life proposal.
If he is successful, Mr Nimmo plans to run the two portfolios separately for the first 12 months. They are very different in character. The Standard Life Trust's portfolio mirrors that of its sister unit trust, a relatively small number of companies selected by Standard Life's own matrix. The Gartmore portfolio has holdings in more than 200 companies, many of which are worth less than £100m and so are relatively illiquid. The key for Mr Nimmo is that the acquisition does not result in dilution for existing Standard Life Trust shareholders, and that he avoids a fire sale of the Gartmore assets. The fact that the Gartmore fund is already 20 per cent cash, will ease that process.
But 2009 will not be all about selling for Mr Nimmo, either in the investment trust or the unit trust. "I’ll be having a good hard look at reducing cash at the tail end [of 2008]. Investors should be doing the same, and looking for high quality portfolios in which to invest."
