Smaller companies will lead the recovery
Ask any investment adviser to name a small companies specialist and the chances are they will nominate Gervais Williams. For as long as most can remember, his name has been synonymous with the art of small cap stockpicking, and for good reason.
As head of Gartmore Investment Management's UK small companies team, his record is impressive.
He manages a number of funds, but is perhaps best known for the Gartmore Growth Opportunities investment trust which is currently riding high, having finished 2009 with its share price up 99% over the year and net asset value (NAV) up by 80%.
Over three years the trust's NAV was up by 30% in a period when the FTSE SmallCap index fell by 40%.
Outperformance of that kind doesn't come easy and is made more striking still when you consider that smaller companies are more often out of favour than in. Lately, though, they have enjoyed an unaccustomed burst of popularity, much to Williams's satisfaction.
"I have been investing in an area that has been out of fashion for 20 years. But now I do think our time has come. We have seen a very sharp recovery in the small cap area. In fact, they led the market recovery.
"I think that is very relevant because on most occasions in the past 20 years recoveries were led by big cap companies," he says.
While the sector as a whole is looking good, that still leaves the problem of stockpicking from a formidable list of candidates. "Our universe is huge - typically more than 1,500 companies," he says.
"But we have a big team. We have five dedicated fund managers and have a huge number of meetings with companies, over 1,000 face-to-face meetings every year, and that doesn't include all the telephone conversations we have."
Picking winners, he explains, is a two-part process. "The first part is that we try to be very open-minded because it is too easy to make investment judgements based on some kind of assumption about the future that might be wrong.
It is much better to meet the companies, and if for some reason we decide not to invest in them at least we have done so from a position of strength, having understood the risks and opportunities.
"The second thing is to be very disciplined about what it is we look for. It has certainly worked in the past and continues to do so, enabling us to deliver very attractive returns. Some will disappoint, but hopefully many more will surprise on the upside."
His approach is heavily bottom-up stock selection. "That is a huge advantage because we don't have to worry about whether the market has bottomed or peaked.
Those are not things that we can control, so it's much better to concentrate on things that we do know about - profits, earnings, sales potential. These are things that we can have an informed view on."
The flexibility of his approach extends to the sectors he favours. "We tend to find that certain ones come to the top of our list at different times. At the moment, we very much favour what I call traded goods.
These are companies that are involved in products that are traded internationally across borders. It could be chemicals, engineering, manufacturing of all kinds, printing, IT hardware and software, and insurance, although we are not quite so excited about insurance.
"All those kind of things have an international marketplace and UK suppliers are getting a relative advantage because of the weakness of sterling."
Renold a linked up strategy
The share that, for Williams, sums up his bottom-up strategy is Renold, a world leader in the manufacture of industrial chains and power transmission products. The trust owns 10% of the shares, having filled its boots through a rights issue.
"It's an unusual company," says Williams. "It is capitalised at only £48 million. It is in a dominant position in its industry and doesn't have much debt. In fact, the rights issue was to repay some expensive debt.
The banks were charging them an arm and a leg for a new facility so by having a rights issue they reduced the costs.
"They've had a tough 2009 as at the beginning of the year their customers said they didn't need any more stock, but now there is a restocking exercise and the underlying position is strong.
"Even before the setback they were targeting a 20% return on capital employed. With the cost savings and additional finance they have raised one hopes they can do better than that.
"We had a small holding for some time, but the rights issue gave us an entry price at an extraordinarily low level. The share price hasn't performed that strongly for the past year, but the chances are we will start seeing a recovery and I think it will be sustained for a number of years."
This article was originally published in Money Observer - Moneywise's sister publication - in March 2010
A way a company can raise capital by creating new shares and invite existing shareholders in the company to buy these additional shares in proportion to their existing holding to avoid a dilution of value, which means keeping a proportionate ownership in the expanded company, so that (for example) a 10% stake before the rights issue remains a 10% stake after it. As an added incentive, the new shares are usually offered below the market price of the existing shares, which are normally a tradeable security (a type of short-dated warrant) and this allows shareholders who do not wish to purchase new shares to sell the rights to someone who does.
Net asset value
A company’s net asset value (NAV) is the total value of its assets minus the total value of its liabilities. NAV is most closely associated with investment trusts and is useful for valuing shares in investment trust companies where the value of the company comes from the assets it holds rather than the profit stream generated by the business. Frequently, the NAV is divided by the number of shares in issue to give the net asset value per share.
Investment trusts are companies that invest money in other companies and whose shares are listed on the London Stock Exchange. As with unit trusts, private investors buying shares in an investment trust are buying into a diversified portfolio of assets (to reduce risk), which is managed by a professional fund manager. Investment trusts differ from unit trusts in two important ways: they are listed on the stockmarket and so are owned by their shareholders and are closed-ended funds with a finite number of shares in issue. This means the share price of investment trusts might not reflect the true value of the assets in the company (known as the net asset value, or NAV) and if the NAV value of a share is £1 and the share price in the market is 90p, the trust is said to be running a discount of 10% to NAV. But this means the investor is paying 90p to gain exposure to £1 of assets. Investment trusts can also borrow money and use this money to buy investments. This is known as gearing and a geared trust is thought to be more of an investment risk than an ungeared one.