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Standard Life's Nimmo calls caution on mature UK bull market

Standard Life's Nimmo calls caution on mature UK bull market

After a six-year bull run pushing equity valuations to above-average levels, Harry Nimmo, manager of Standard Life UK Smaller Companies Trust, is now ‘slightly cautious’ on the outlook for UK equity markets.

This year, for the first time in six years, he did not seek to exploit a seasonal rally in small caps.

Every year since 2009, except this year, Nimmo has increased gearing significantly in November and reduced it in May to take advantage of the typical small cap seasonal rally. Every other year, he took gearing to about his maximum of 8%, but today it stands at around 2%.

The trust has a £25 million 3.5% convertible unsecured loan stock issue, which expires in 2018, £20 million of which is outstanding.

‘Smaller companies tend to perform particularly well in the first quarter of the year. This pattern mainly relates to the lack of new issues and placings over the Christmas period and the first couple of months of the new year,’ said Nimmo.

‘Increasing the gearing before Christmas in the earlier years of this bull market has worked well for us. This year, I only added to it modestly.

'In hindsight, I should have put in a whole lot more – markets have conformed to that seasonal pattern, with the past four months being incredibly strong.’

Standard Life UK Smaller Companies Trust

  • Sector: UK – Small Cap
  • Discount to NAV: 10%
  • Market cap: £201 million
  • Net yield: 1.6%

Maturing bull

‘However,’ said Nimmo, ‘we’ve now been in a bull market for six years. The cyclical recovery is actually quite mature, and stock markets tend to anticipate the turning point quite early.’

He points to interest rates being at ‘almost unnatural lows’ for a prolonged period. ‘Far be it for me to predict a raging bear market, but it feels like markets have been so good for so long,’ he said.

‘When interest rates are really low for extended periods, investors put money into tangible assets, raising the prospect of an asset bubble.’

Performance has weakened over the past year

Sister funds

Beyond gearing, Nimmo’s concerns have no bearing on how he runs the trust: a fairly concentrated portfolio of 60 stocks that have the potential to grow, regardless of the economic environment.

‘Our process is resilient to more difficult market conditions; we have no fear of them,’ he said.

As well as the £205 million investment trust, Nimmo manages a £1.1 billion open-ended fund, the Standard Life UK Smaller Companies fund, with which it has 80% overlap.

He said the trust’s smaller size enabled it to be more nimble and invest further down the market capitalisation scale.

Over the past five years, the shares of the investment trust have returned 120.1% in share price terms and 125% in net asset value (NAV) terms, compared with a 95.4% rise in the FTSE Small Cap (ex Investment Companies) index. The open-ended fund has returned 103.3%.

For both funds, Nimmo adopts a three-stage process: philosophy; screening; company meetings.

First and foremost, he looks for momentum (companies with earnings and price momentum, undergoing improvements), quality (companies with predictable earnings streams and long-term client relationships) and growth (companies in growing business niches).

The screening process, used by Standard Life Investments since the mid-1990s, measures momentum, quality and growth on 12 factors and takes Nimmo’s universe of 700 stocks down to a shortlist of 100-150.

This matrix is updated daily and informs companies meetings, at least two of which he and his team undertake daily.

Using this framework he shies away from cyclical businesses, such as house builders, building materials suppliers and the more mature end of manufacturing industries. Conversely, he is overweight retail and healthcare.

His retail holdings include fashion shop Ted Baker, furnishings chain Dunelm, car dealership Lookers and Poundland. His healthcare stocks include Cambridge-based Abcam, Dechra Pharmaceuticals, CVS, BTG and NMC Health, an Abu Dhabi-headquartered business he picked up in March.

Other recent additions to the portfolio include bakery chain Greggs, in February; Secure Trust Bank, a ‘challenger’ bank benefiting from the demise of high street banking, in November; and Clarksons, the world’s largest ship broker, also in November.

Last year, Nimmo sold Asos, which he bought in 2006 at 80p, for an average price of £47, with the position being closed out in May.

‘The real money in smaller companies is in holding great companies for many years,’ he said.

Sector breakdown

Small stock turnover

The trust’s turnover is typically less than 25% per annum, with an average holding period of four to five years.

Other sells include Kentz and CSR, both of which were subject to takeover bids, software business Aveva and online insurer Esure, which the trust sold at a loss after the position ‘didn’t pan out’.

The trust has been run in this way since Standard Life Investments took over the mandate from Edinburgh Fund Managers on 1 September 2003, and is credited with turning around performance.

It was the best-performing investment trust in the 10 years to 31 August 2013, albeit partly on account of the discount narrowing from 34% to 0%.

Of late, the discount has drifted to 10%. The board has a discount control mechanism under which it buy back shares at around 10%.

Despite its stellar long-term record, the trust has struggled in the past year after stocks in the bottom half of the FTSE 250 index, where the lion’s share of its holdings are, suffered in the second quarter of 2014.

‘Multi-asset investors adjust exposures by selling exchange-traded funds or FTSE 250 futures and that has an exaggerated effect on the smaller constituents of that mid-cap benchmark, where a lot of our holdings are, but performance has recovered quite strongly since July 2014,’ said Nimmo. 

TOP 10 HOLDINGS

ADVISER VIEW

Peter Lawrence

Principal, Prime Time Financial

In 2013, Standard Life UK Smaller Companies was the best-performing fund in the UK over 10 years. Things have been significantly less rosy, though, over the past year or so.

Nobody ever doubted that smaller companies would be volatile, and in 2014 the sector suffered, reportedly from comments from the US Federal Reserve.

On top of that, the particular style of stock selection in smaller companies funds is going to mean differences between them.

Smaller company volatility was illustrated in the fund by the purchase of Blinkx, which went downhill in 2014 after some bad publicity.

While confidence has been knocked, the experience and past performance of the fund manager is a major factor to consider. Further, the fact the fund is now firmly in discount territory may mean a good opportunity to buy.

For me, it continues to have a place in relevant client portfolios, where long-term performance and confidence, as well as low costs and transparency, are concepts that will keep clients on side.

Fund manager Harry Nimmo once said: ‘Our aim is to be exposed to predictable growth, but in a lower risk way.’ We’re looking out for that aim to be realised.

ANALYST VIEW

John Newlands

Head of investment companies research, Brewin Dolphin

I regard this as one of the best trusts in its sector.

Harry Nimmo has a real flair for identifying smaller companies, and it would be wrong to judge him on a near-term view. His long-term performance figures remain excellent.

I also like the fact he has access to the massive resources of the Standard Life UK equity team. This uses UK Matrix, a proprietary stock-ranking tool, as a key quantitative input.

This methodology identifies which style factors are working at any one time, highlighting investment themes and helping to provide the market context for successful stock selection.

The trust has a fairly robust discount control policy, aimed at keeping the rating in low single figures, if possible.

Semi-annual tender offers may also be made, at the board’s discretion, with the same aim in mind.

The previous performance fee arrangement was removed in late 2012 and replaced by a slightly higher base fee of 0.85% of net assets per annum.

In an increasingly competitive world, we would now like to see further downwards pressure applied to this figure. Overall, though, this is class act and one we remain happy to recommend.

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