Small can bring big returns

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INVESTING IN smaller companies requires a particular expertise: the ability to assess and evaluate many differing businesses.

Richard Smith, with a 33-year investment career, always wanted to be in fund management. "I didn't go to university, but straight into Midland Bank," he says. "And I was investing on my own account. Then I joined Harris and Partners, who were Canadian stockbrokers." He sat the Canadian Stock Exchange exams and became an institutional trader.

"If you are a broker, you do all the research and have the ideas but no one has to buy them. If you are a fund manager, you can do the same work and take the investment decisions yourself."

Richard Smith has worked for Lazards since 1975, initially investing in American companies and heading the firm's US team. But in 1988, Lazards moved its US fund management operation to New York, and the London-based Mr Smith switched to UK firms, which included managing the Lazard UK Small Companies Growth Trust.

Lazards' unit trusts were set up as vehicles for the firm's clients but have become more generally available to private investors. "The funds we manage are essentially institutional monies, where we are trying to achieve good, solid long-term performance. We hope to give our unitholders a steady ride, rather than a volatile one."

One of the key elements in managing a smaller companies portfolio is the emphasis on identifying individual stocks. Mr Smith says: "You can't be a closet index fund. You can't track the Hoare Govett Smaller Companies Index (HGSCI) because it includes 1,500 shares. Our fund would hold around 110 shares and out of a universe of only 600 or so that would interest me.

"There is an increasing difference in the small-cap market between the `emerging companies' and the `submerging companies', between companies which have control over their destinies and those which don't. We want to invest in emerging companies which are in control".

Mr Smith cites types of company to avoid. "All my investing life, textiles has been a no-go area. Every time you invest in textiles, you lose money. Now there are an increasing number of no-go areas. Sectors such as retail and restaurants are highly oversupplied in the UK and companies have to really stand out to be of interest. You must be selective."

The partly institutional nature of his fund also governs the way it is managed. "We try to be risk-averse, to screen companies by assessing their business, their valuation and their share price characteristics. We don't like firms heavily dependent on supplying one company, we don't like one-product companies but we do like managements which have been around for a while and survived tough times. We look for companies with unique elements.

"With earnings, we are looking for solidity. We don't want to invest in companies which are going to give us profit warnings. In terms of valuations, we are looking at value relative to the market as a whole, and to the sector and the company's peer group. In the small-cap area, earnings estimates are not a perfect science. By meeting company managements, you often get a feeling companies are doing better - or worse - than the consensus forecasts."

Mr Smith has examples of these principles. "One of our major holdings is Carpetright, the largest chain of carpet stores in the country. What makes it attractive is that it is dominant in certain aspects of the carpet market and has no major competitor. Another is Taylor Nelson, only separately quoted market research company in the UK and the fourth largest market research company in the world. Yet it is still a UK smaller company."

His trust has benefited from this year's resurgence in the small-cap market. Mr Smith says: "One feature has been merger activity. In the first halfthis was worth pounds 12bn, more than 10 per cent of the starting value of the HGSCI. This means performance has been skewed more towards value situations than growth situations." He also sees technology as an increasingly important area. "The days are gone when you could say, with confidence, that smaller companies would inevitably outperform in a rising economy. You must become more selective and the UK is probably going to follow the US to become more technology-driven. A lot of emerging companies will be in technology.

"And we tend to be value players. We have traditionally not wanted to play in loss-making companies and we haven't gone against that, but you have to live with what the environment is and not what you would wish it to be."

The portfolio reflects the predominance of certain types of company, with two sectors, services (45.79 per cent) and general industrials (30.41) accounting for more than 75 per cent of the holdings. Other significant sector weightings are 10.69 per cent in financials and under 8 in consumer goods.

The spread is broad for a trust size that nudges pounds 100m, with 111 holdings. The largest, McAlpine, accounts for 2.65 per cent of the portfolio and the combined value of the top 10 holdings is 22 per cent. Other major holdings are Taylor Nelson (2.58 per cent), Goode Durrant (2.49), Carpetright (2.42), Norcros (2.4), Seton Scholl Healthcare (2.35) and Birkby (2.12).

But Richard Smith points out that the sector spread is merely a function of the types of stocks that look attractive. "We are a little overweight in the construction area, which we are not overly pleased about, but there have been a lot of good-value situations in the area.

"The market seems to have reacted to interest rates and sectors as it normally would, and these companies have suffered over the past few days."


Fund Manager: Richard Smith

Age: 51

Fund: Lazard UK Small Companies Growth

Size of Fund: pounds 96.89m

Fund Launched: February 1963

Manager of Fund: Since September 1988

Current Yield: 1.29%

Initial Charge: 5.25%

Annual Charge: 1.50%

Current Bid/Offer Spread: 6.50%

Minimum Investment: pounds 1,000

Minimum Monthly Savings: pounds 125

Standard & Poors' Micropal Rating (maximum KKKKK): KKK

Fund performance to 1 September 1999 (offer-to-bid, with net income reinvested):

One Year 22.56%

Two Years 31.29%

Three Years 29.44%

Five Years 73.61%

Seven Years 194.94%

Ten Years 160.22%