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Nimmo nightmare: ‘prodigious underperformance’ blamed on derivative onslaught

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Nimmo nightmare: ‘prodigious underperformance’ blamed on derivative onslaught

Harry Nimmo has attributed the sharp decline in his performance to derivative traders taking fright at signs US interest rates could be on the rise.   

In the 12 months to 30 June Nimmo’s Standard Life UK Smaller Companies trust returned 7.7%, well below the 20.3% return in the Numis Smaller Companies index, following a loss of more than 11% in the second quarter. 

This return has tarnished Nimmo's long-term record although he remains ahead of the benchmark, returning 410.4% over the last 10 years. This gives an annualised return of 16.2%, outperforming the benchmark equivalent by 3.3%.

Yellen fever

Nimmo divided the year into two halves, with 7 March being the turning point when new Federal Reserve chair Janet Yellen raised the possibility of an earlier than anticipated rise in US interest rates.

‘The market seized on her rather laconic comments that the time difference between the end of quantitative easing (QE) and the first rate increase could be six months, thus bringing forward the market's expectation of such an event by around nine months,’ Nimmo said. 

‘While not earth-shattering in itself it did cause investors, particularly in the US, the UK and Japan, to re-examine the risk profiles in their portfolios in what turned out to be a dramatic fashion.’

Up to this point investors were happy to take on risk and support high growth companies, Nimmo pointed out.

However, following Yellen’s comments investors, including 'increasingly influential global multi-asset' managers, scaled back risk. 

Nimmo said this was often achieved through indirect methods such as derivatives, or selling exchange traded funds. This in turn caused selling in the underlying holdings and prompted downward pressure on the smaller constituents of the FTSE 250, which are among his trust's biggest holdings.

‘After 6 March, the company suffered under the onslaught of derivative-related selling activity at the lower end of the FTSE 250,’ Nimmo said.  

‘Our approach is to identify companies which exhibit strong quality, earnings visibility and price or earnings momentum and in this environment these companies underperformed.’   

The number of new issues also hindered Nimmo. ‘Fund managers who wish to participate in these new issues tend to sell previous winners, especially existing retail holdings.

‘High growth stocks which did particularly well in the preceding period were sold due to being seen as high risk.’   

He added: ‘The extremely benign nature of the economic backdrop in the UK and worldwide meant that quality, strong balance sheets, cashflow and earnings visibility were no longer regarded by some investors as positives.

‘Indeed given the maturity of the recovery, which after all began in 2009, our favoured holding type looked pedestrian when compared with the seeming performance of the more cyclical recovery segment.

‘Underperformance was prodigious, to the extent that the return for the year in question was most disappointing.’

Winners & losers

Nimmo’s poorest performers over the period included online bookmaker Paddy Power: ‘Its UK markets have become more competitive in the last year due to tougher regulation’. He has since sold down the stock.

Other weak spots included water purification company Waterlogic and online antibody distributor Abcam, along with Blinkx and Xaar.

Among the carnage Nimmo had a number of good performers.

He highlighted Hargreaves Lansdown, Safestyle, Andor TechnologiesGB Group and Kentz Corp among the stars.

Commenting on Hargreaves Nimmo said: ‘The on-line financial services provider continued to perform well even though their business environment was rendered uncertain by regulatory change.’

However, the rise of Hargreaves has forced Nimmo to sell down the holding. ‘We continue to scale out of this holding as it has moved right on through to the FTSE 100 Index…this company has done its job and can no longer be  defined a smaller company.’    

Buys & sells

Nimmo bought several new positions over the period, which including re-acquiring a stake in Big Yellow Group. ‘Significant capital investment has been made and it is simply a case of seeing the company benefit from increased utilisation rates,’ he said.

Other new positions include KellerCranswick and Ocado, which was purchased following its deal with Morrisons.

To facilitate these he sold long-time holding Asos, which like Hargreaves had grown too big for a smaller companies portfolio.

He also cut Xaar and Domino’s Pizza, one his long term favourites. ‘[Domino's Pizza (UK & Ireland)] was sold following a successful nine years in the portfolio. Its UK business was becoming mature and the expansion into Germany had been problematic,’ he explained.

Outlook

With rates on the rise and quantitative easing coming to an end Nimmo suggests things are going to get a bit tougher for smaller companies.

‘Whilst investment returns should be good over the next five years, it is unlikely that smaller companies will deliver the spectacular returns of the previous five years,’ Nimmo said.  

‘A period of rising interest rates may begin later this year which should temper the extraordinarily supportive current business environment. 'Boom and Bust' is not over.

‘The interconnectedness of global markets and banking systems, the very high levels of sovereign and personal debt and increased levels of geopolitical instability, particularly in regions where vital oil & gas resources are to be found, all suggest that caution should be the watchword.’

But the recent turbulence has not swayed him from his investment process.

‘It has generally worked well over the past ten years and we see no reason for this to change, Nimmo said.  

‘The vast majority of our companies have net cash positions and can grow from internally generated cashflows in a predictable way.

‘Dividend growth is strong and special dividends are quite plentiful without compromising growth prospects. This all gives us great confidence in the long term outlook for the company.’

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