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Old Mutual’s Nickols: Undiscriminating sellers are hurting small-caps

Old Mutual’s Nickols: Undiscriminating sellers are hurting small-caps

Dan Nickols, the Citywire + rated manager of the £919 million Citywire Selection Old Mutual UK Smaller Companies fund, has blamed small-cap tourists for the sector’s recent weakness.

In the first half of the year, the Numis Smaller Companies excluding Investment Trusts (NSCI) index lost 0.6%, while the FTSE All Share gained 1.6%.

‘There are clearly suggestions around the market that a range of market participants that would not necessarily be regarded as natural holders of the UK mid and small-cap space,’ said Nickols (pictured).

‘By that I mean large-cap managers and perhaps US investors, but who nonetheless have added significant value over the course of the last two to three years to their performance from having invested in this space – are reducing exposure to this area.

‘You cannot underestimate the technical aspect to the sell-off we’re seeing. There is a very mechanical link between the businesses that generally have performed very well over the course of the last two to three years and the fact that those are the very same names that are being most aggressively sold off.’

As examples of those hit by this flight, Nickols cited Restaurant Group and Telecom Plus, both of which he owns in his top 10. The two soared by 55% and 96% respectively in 2013, but over the past three months have plunged by 11% and 19%.

‘One of the compounding factors in all this is that the exit has been done, in some cases, in a fairly disorderly fashion,’ Nickols said.

‘People just want out of this space,’ he claimed, prompting ‘non-discriminating selling’.

‘In the near term, it is very difficult to know how long that phenomenon may last,’ he added.

Looking further ahead, however, Nickols expressed confidence that small-caps are not on the brink of a prolonged slump.

‘There was a perception a couple of months ago that UK mid and small-caps had become very expensive in valuation terms. But after the relative weakness of the second quarter, I think it is perfectly justifiable to argue mid and small-caps are now very similarly valued to the wider UK market,’ he said.

‘And in our view at least, fundamentally they enjoy earnings growth prospects [that are] at least as good.’

Nickols highlighted data from Peel Hunt as evidence. By the broker’s reckoning, the forward price-to-earnings ratio excluding loss makers of the FTSE 100 is 13.6x and 14.6x for the FTSE 250. For the NSCI, it is 13.5x. The small-caps also boast the best forward earnings-per-share growth, at 9.6%, compared with 5.6% for large-caps and 9.2% for mid-caps.

He is therefore sticking by his holdings, which are split broadly into three themes.

These include structural growth businesses, such as Just Eat and Telecom Plus, and companies sensitive to economic growth, including car dealer Lookers and broadcaster UTV. Special situations are another them. Holdings here include BTG, thanks to its varicose vein treatments, and retailer Findel due to its new management.

‘I don’t look at the portfolio and fret that we are fundamentally in the wrong sorts of businesses,’ Nickols said.

He described the fund’s recent performance as ‘lacklustre’, although over the past three years it has still beaten the peer group with a return of 48.6% versus the sector average of 45.8%.

‘In the very short term, it is difficult to argue that we can do anything dynamic to change the situation. What we can do, and what we are doing, is continuing as we always do to scrutinise each position in the portfolio, test our thesis, test whether we are happy with the investment case,’ he said.

‘We have been trying to maintain focus in the portfolio, use weakness to augment positions where our conviction levels are high, be honest with ourselves where they are not, and weed out what we consider to be some of the weaker holdings.’

So far this year, for instance, Nickols has exited video advertising firm Blinkx. Its share price halved to £1 through January and February after a blog attacked its business model. Nickols sold out around the £1 mark, and the stock has continued to slide since to less than 40p now.

In contrast, Nickols has been topping up Telecom Plus on recent weakness on the belief it has ‘many years of premium levels of growth to deliver’.

Similarly he bought into Boohoo at its March listing, and has kept faith despite its placing price of 50p dropping to around 35p today. ‘Over time, as the company publishes trading results, the share price will respond accordingly.’

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