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Hold or Fold: Merrill Lynch UK Smaller Companies vs Gartmore UK & Irish Smaller Companies

This week the panel concentrates its gaze on a pair of funds in the smaller companies sector and despite one fund’s impressive absolute returns it is still not enough to spare it from a thumbs down.

MERRILL LYNCH UK SMALLER COMPANIES

WHAT NEW MODEL ADVISER® SAYS:

The fund (Merrill Lynch UK Smaller Companies Inc) is run by Black Rock Merrill Lynch Investment Managers and its aim is to achieve long-term capital growth. The fund invests primarily in the shares of smaller companies incorporated or listed in the UK and is also allowed to invest in collective investment schemes. Smaller companies are defined as those companies whose market capitalisation is not more
than £1 billion.

WHAT BLACKROCK MERRILL LYNCH SAYS:

‘The smaller companies market continued its recent positive run in May with all indices producing a positive performance,’ says BlackRock Merrill Lynch. ‘During May we added new holdings in Gem Diamonds and Worthington Nichols and added to existing positions in Maxima, Mouchel Parkman and Domino Printing. We sold our holdings in Datamonitor, Gyrus and Statpro. The recent round of trading updates from the majority of our investments has continued to be encouraging, and we will continue to invest in high quality companies with consistent track records of earnings growth and cash generation that demonstrate an ability to grow ahead of the market.

WHAT THE ADVISERS SAY:

Tim Ames, Director, Cathedral Financial Management

Manager Richard Plackett has been described as the next Anthony Bolton and is certainly one of the more successful stock pickers around. He has consistently delivered the kind of returns that mean this fund’s second quartile performance over a year is not of great concern. Over three and five years the fund is top decile and notably has very strong Treynor and Jensen’s alpha ratios, illustrating the high level of returns achieved per unit of systemic risk.

This fund is run with a strong bottom-up stock picking approach and the huge number of company meetings held by the manager annually is testament to the depth of research which goes into the decision-making process. The fund has performed well in positive and negative markets and takes relatively little risk to achieve its added value. Definitely a hold.

Christopher Morris, Investment adviser, Collingwood Mourton

This is the much stronger fund of the two portfolios on show this week with a top-class AAA Citywire-rated manager, Richard Plackett at the helm. This is reflected in the fund’s performance, which exceeds its peer group average over one, three, five and 10 years, achieving either first or second quartile positioning. Despite my greater belief regarding large cap stocks in general, this fund has to be a hold for those investors content with ongoing small cap exposure.

Steve Buttercase, Independent financial adviser, M2 Financial

Smaller company funds rely on the quality of their research and the stock picking capabilities of the portfolio manager. There are no short cuts and the performance of this fund highlights the strength of the manager because he really knows his holdings. The portfolio balance is away from consumers and weighted towards IT. I think that is shrewd as interest rates rise and the feel-good factor of house prices starts to ebb away.

If I have any reservations it is watch out for any recessionary evidence in data as small companies inevitably fall fastest and hardest. But that aside this
is a strong hold.

GARTMORE UK & IRISH SMALLER COMPANIES

WHAT NEW MODEL ADVISER® SAYS:

The fund (Gartmore UK & Irish Small Companies) aims to achieve a long-term return in excess of the long-term return that is typically achieved from UK and Irish smaller companies’ equities markets by investing in: smaller companies having their registered office in the UK and Ireland; smaller companies that do not have their registered office in the UK nor Ireland but either (a) carry out a predominant proportion of their business activity in these markets, or (b) are holding companies which predominantly own companies with registered offices in the UK and Ireland. The benchmark is the FTSE Small Cap (exit) Index.

WHAT GARTMORE SAYS:

‘We remain positive about the prospects for small-cap shares and continue to identify and invest in fast-growing businesses delivering premium returns,’ says Gartmore. ‘At the end of May 2007, the fund ranked in the fourth quartile of its peer group over three months, despite outperforming its benchmark over five and 10 years. In April 2007, the fund’s holdings in the TV set-top box maker, Pace Micro, and mining company, Kenmare Resources contributed most positively to performance. Pace Micro announced its plan to launch a home multimedia centre under its own brand name during the month. Meanwhile, Kenmare benefited from optimism about its titanium-minerals project in Mozambique.’

WHAT THE ADVISERS SAY:

Tim Ames, Director, Cathedral Financial Management

This fund has had a torrid time, underperforming its peer group over one, three and five years. The fund is managed by two very experienced small cap managers in Gervais Williams and Rob Giles, but after a strong 2003 their significant growth bias has failed to reward investors. From April 2004 the fund’s performance started to trail and during May 2005 the significant overweight in oil and resource stocks brought the fund down roughly 5% relative to the sector. Despite a few short periods of recovery since it has underperformed for three years now. While still returning over 65% over the last three years to March 2007 there are other funds which have provided nearly double that. Although the management may argue that the current environment looks promising for their approach, I’m afraid this is a fold.

Christopher Morris, Investment adviser, Collingwood Mourton

The smaller companies sector is one which has delivered strong returns over the recent past, although I believe it will be outshone in the forseeable future by large cap stocks. While performance is impressive in absolute terms, it has delivered below its peers in the UK smaller companies sector over one, three, five and 10 years. The fund is also showing greater volatility than the sector as a whole, as measured by its beta, while its negative alpha figure indicates the fund managers are not providing any out-performance. Fold.

Steve Buttercase, Independent financial adviser, M2 Financial

Despite a creditable performance over five years, it is below the sector average. This fund appears to have the right weightings but the wrong stocks and therefore it has not really shone in the same way as the other fund. The top holding, Pace, is a big player in internet TV, Broadband and set-top boxes but it still stubbornly refuses to realise its early potential. That the fund remains wedded to the company may indicate confidence in the future or a lack of judgement to drop stocks that don’t deliver. Time will tell, of course, but my feelings are this fund is not a premier league performer. Fold.

NEW MODEL ADVISER’S® VERDICT

MERRILL LYNCH UK SMALLER COMPANIES

The panellists could find no chinks in the armour of this portfoliomaking it a resounding HOLD.

GARTMORE UK & IRISH SMALLER COMPANIES

Sadly, despite some impressive absolute return figures this portfolio fails to set light to any of our panellists’ imaginations this week. FOLD.

TWIST

Old Mutual UK Select Smaller Companies (Old Mutual UK Smaller Companies Inc) run by Citywire AAA-rated Daniel Nickols is a favourite among IFAs.

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