Exploit smaller company growth with Marlborough Special Situations

"Technology has radically altered the ease with which smaller companies can grow," says Adrian Lowcock, senior investment manager at broker Hargreaves Lansdown. "Where previously they might operate solely in a local market, now the internet allows them to access a global client base at minimal cost. They are also frequently able to adjust rapidly to changing circumstances and successfully exploit niche markets. Their size means they have enormous growth potential - it is far easier to double profits of £5m than £500m."

But making good returns from smaller companies relies on picking the right ones, especially in a higher-risk area like this. So in this segment of the market it could be worth investing with a fund manager who can identify the smaller companies that will outperform.

One such example is Giles Hargreave. We already include his Marlborough UK Micro-Cap Growth Fund (GB00B02TPH60) among our IC Top 100 Funds (read our tip on this). But if you want to access his stockpicking skills via slightly larger (and arguably less risky) companies, then consider Marlborough Special Situations Fund (GB00B659XQ05).

Whereas Marlborough UK Micro-Cap Growth has 77 per cent of its assets in companies with a market cap of less than £250m, Marlborough Special Situations has 35 per cent of its assets in companies this size. It has a further 37 per cent in companies with market caps between £250m and £1bn, and 22 per cent in companies with market caps between £1bn and £5bn.

Marlborough Special Situations has performed strongly over longer periods, beating its benchmark the IMA UK Smaller Companies sector average, as well as the FTSE SmallCap index ex investment companies over three and five years.

Mr Hargreave mitigates some of the risks of investing in smaller companies by having a large number of holdings in Marlborough Special Situations, currently 249. He initially makes small investments, usually less than 1 per cent of the portfolio, and builds positions over time - no one holding currently accounts for more than 1.6 per cent of assets.

Mr Hargreave and his team seek a combination of growth and value potential, using various measures and criteria such as the price/earnings to growth (PEG) ratio, how sustainable the stock's growth is likely to be and whether it is generating cash in line with its profits. They also look at a company's debt profile, the quality of the management and how long it has been there, and whether the company's growth is driven by acquisitions or sustainable internal growth.

Read our last interview with Giles Hargreave to learn more about how he picks shares

Although Marlborough Special Situations is focused on smaller companies with larger market caps, these are still relatively risky and more prone to failure than large-caps, and can be more volatile and less traded.

Marlborough Special Situations has not performed so well over one year, lagging both its sector and the FTSE SmallCap Index. But smaller companies funds invest for the long term as sometimes it can take time for their investments to come to fruition, meaning short-term numbers are not as important.

So with strong long-term numbers and a highly experienced manager with a proven investment process, Marlborough Special Situations is still worth considering. Buy.

Source: Morningstar, *Marlborough.

Morningstar as at 22 April 2013

Top ten holdings as at 2 April 2013

Sector breakdown