Austerity measures in the UK should not present a problem for small-cap investors provided they choose their shares carefully and look for companies with an international focus, says Giles Hargreave, manager of the Marlborough Special Situations and UK Micro Cap Growth funds.
"We tend to invest in companies that are not very UK-economy-focused because the austerity measures are not good for consumer spending," explains Mr Hargreave. "We only own one retailer, Supergroup, and hold no banks or housebuilders. The two small property companies we own, Helical Bar and Conygar, are more focused on property operation and investment.
He insists that, while the smaller-cap end of the market tends to be more domestically focused, there are plenty of international outfits to choose from. "The Alternative Investment Market (Aim) is full of companies that operate outside the UK. There are, for example, many engineers listed on this market that operate internationally, and we hold quite a few of these," he says, citing Titan Europe and Pressure Tech. Both are held in the Marlborough UK Micro Cap Growth Fund, which like its stablemate is among the top-performing UK smaller company funds.
"If these companies are left to their own devices they should benefit from growth in economies that are growing faster than the UK, so their prospects are very good," says Mr Hargreave. "Sentiment towards equities could change, although just now they are preferred to bonds and most indications are very positive."
Does the strong rise in smaller-company share prices during 2010 make him nervous about a correction? "Because valuations are quite a lot higher we have to be more careful with stock picking, as this end of the market is more vulnerable to a sell-off," he says. "If we buy a stock on a higher price-earnings (PE) ratio we have to have a good reason for doing it."
Giles Hargreave
But being careful is part and parcel of small-cap investing generally. Mr Hargreave says it is important to be more discriminating when investing in smaller companies, because their share prices may fall 50-60 per cent on just a single profit warning. "The more initial research you do the better, so you can anticipate something before it goes wrong. Liquidity in the stock is also quite relevant among smaller companies because there can be great variations," he adds.
The right ones
When looking for a stock, Mr Hargreave and his team want a combination of growth potential and value. He heads a team of eight, including two full-time analysts, who focus on researching companies. "Having a large team enables us to cover many more stocks than others might be able to," he says. "When an interesting stock comes to our attention it is rare that somebody on the team does not know something about it. Whoever knows the most about the stock will do the main research on it and then discuss it with me. We also have more formal meetings at which we discuss many stocks."
Mr Hargreave and his team use various measures and criteria to decide whether to buy. These include the PE-to-growth (PEG) ratio; how sustainable the company's profit growth is likely to be; and whether it is converting its accounting profit into cash flow.
| Giles Hargreave CV |
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Giles Hargreave has been manager of the Marlborough Special Situations Fund since 1998. He also runs the UK Micro-Cap Growth Fund and is co-manager of the Marlborough UK Leading Companies Fund. Mr Hargreave is chief executive of stock brokers Hargreave Hale, which runs two AIM venture capital trusts (VCTs). He founded Hargreave Investment Management in 1986, which was merged with Hargreave Hale in 1988 at which time he took over as chief executive. Mr Hargreave started his career in 1969 as an analyst with James Capel, after which he became a private fund manager at Management Agency and Music in 1974. |
They also look at a company's debt profile, the quality of the management and whether the company's growth is driven by acquisitions or sustainable internal growth. Mr Hargreave generally prefers the latter, but adds: "If you find that a company is growing reasonably on its own, what does it do with the cash that just now yields nothing? In such a case maybe it is better that the company makes acquisitions, especially as you can buy them for low valuations and increase earnings."
The team will sell a stock following a major change at the company; for example if a previously good manager has retired. A stock becoming overpriced is also a sell trigger. "But we are careful here - you might want to excuse this in very good companies because you may never get the opportunity to buy them back at a good price," adds Mr Hargreave.
It is also important to make sure holdings do not become too large. "Generally we don't hold more than two per cent of a company, and never more than three per cent," says Mr Hargreave.
From the top
Given his preference for companies with an international bent, it's no surprise that Mr Hargreave has extensive positions in the commodity sector, with a preference for oil. "Regarding sector views, we have been reducing exposure to gold companies a bit as the price comes down, because if interest rates go up globally it will not be good for this asset. However the reduction in exposure has been very modest," he says.
"Oil is at around a $100 a barrel while the cost of production is below $30 a barrel," explains Mr Hargreave. "So when a company makes a discovery its share prices goes up a lot." He points to Nautical Petroleum, for example, whose shares have risen from around 50p to near 500p following some discoveries in the North Sea.
Other oil company holdings include Encore Oil, Premier Oil, Egdon Resources, Valiant Petroleum, Providence Resources and recent addition Salamander Energy.
