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

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