Mark Dampier: Smaller companies can provide big opportunities

The Analyst

Most commentators continue to view larger companies in the UK and around the world as the place to be, myself included. The vast majority have become cheaper over the last 10 years, and the likes of GlaxoSmithKline, Vodafone (and arguably BP, in spite of its current problems) do look good value. In particular, their dividend yields are attractive, at 5 per cent or more in many cases. They also benefit from deriving much of their earnings from overseas, and in currencies other than sterling, notably the US dollar. The increase in these currencies against the pound, which has been comparatively weak over the last couple of years, has enhanced their profits markedly.

By contrast, the general assumption is that smaller companies are domestically orientated and not a good place to invest given the problems faced by the British consumer, not to mention the Government. However, small company investing has evolved over the last 25 years. At one time it was centred on UK-focused engineering companies in the Midlands and the North. Things have since changed, and if we look at the Hoare Govett Smaller Companies Index (which has rallied by around 35 per cent over the last 12 months, outperforming large caps by quite some way), we find that around 40 per cent of company earnings are now from outside the UK. So the idea that a UK Smaller Companies Fund only offers domestic exposure is mistaken.

While the FTSE 100 is dominated by relatively few companies, the UK's smaller firms can also offer important diversification to investors through exposure to a wide range of sectors. Resources, chemicals, consumer goods and technology companies are all areas where overseas exposure can be significant. One smaller companies fund with a large international exposure is the Old Mutual UK Select Smaller Companies. Under the management of Dan Nickols, it has performed exceptionally well over the last five years, increasing by 87 per cent against the sector average of 29 per cent, a strong run that has also easily outstripped larger company funds.

Although overseas earners offer some good opportunities, Mr Nickols believes there is plenty of scope in certain domestically orientated stocks which have exposure to long-term growth trends. These include companies such as Rightmove, which has changed the way in which people search for properties. He also sees opportunities in engineering firms, including Cookson and Weir, where he believes analysts' forecasts are too pessimistic and he expects to see upgrades in earnings forecasts.

The fund managers I have spoken to over the last few weeks all report companies performing ahead of expectations, exactly the kind of news you want to hear because this is what tends to drive share prices higher. In terms of present valuations, smaller companies' stocks at first glance look more expensive than larger ones. However, Mr Nickols expects annual earnings growth to be at least in the mid-teens, which makes the market look pretty cheap.

So here we have a fund with a good blend of top domestic stocks alongside plenty of international exposure benefiting from the fall in sterling. Yet smaller companies are often ignored by private investors for reasons I don't really understand. Over the longer term they tend to outperform larger stocks and offer active fund managers such as Mr Nickols and the team at Old Mutual a chance to add considerable value. While the headlines in the papers might make you feel somewhat nervous, the truth is that many companies continue to prosper and generate profits despite what is going on in the global background. In my view, the Old Mutual team are second to none in this part of the market and this is an excellent fund to tuck away for the long-term.

Mark Dampier is head of research at Hargreaves Lansdown, the asset manager, financial adviser and stockbroker. For more details about the funds included in this column, visit www.h-l.co.uk/independent

Independent Partners; Do you need financial advice on your investments, pension or insurance? Book a free consultation with an independent Financial Adviser at VouchedFor.co.uk

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