UK Opportunities Fund - opportunities in small cap market

Neil Veitch, SVM UK Opportunities Fund, highlights opportunities in small cap market: Fear and greed are the most basic human emotions and fear of the unknown is currently driving equity prices. The trigger for a sustainable rally will occur when the market can, on a balance of probabilities, bottom the extent of the economic downturn. The question is when can we expect this to happen?

It may prove impossible to accurately predict when the market will bottom, but in the meantime there are still opportunities for the disciplined investor.

Despite many stocks having dropped 40% from their peaks, there have been few significant changes made to profit forecasts. As ever, the key to success is found in avoiding those situations where an optically ‘cheap’ valuation is undermined by sustained earnings downgrades. We are increasingly finding a number of interesting opportunities, in both stocks that have declined considerably, where we believe the fundamentals are intact, and those stocks previously exited on valuation grounds that have become attractive again.

Small-cap stocks have, in many cases, been sold-off indiscriminately regardless of the fundamentals. Three such stocks are Elementis, Novae and Morgan Sindall, all of which have recently been added to the SVM UK Opportunities portfolio.

Elementis

Elementis has transformed itself over the last few years into a true specialty chemical business. The sale of the pigments division has removed a low margin business, left the company virtually debt free and leaves scope for a significant return of cash to shareholders. Operating margins are currently c.17-18% with scope for further improvement.

Novae

Novae, formerly known as SVB Holdings, is a Lloyds underwriter with a chequered history. Despite the substantial improvements in the company, it is currently valued at less than its stated net tangible assets, and at a significant discount to the sector. A number of its peers have seen takeover approaches in the last six months and if Novae were to receive such an approach, the shares would almost double in value.

Morgan Sindall

Morgan Sindall is a diversified construction business. The group has grown strongly over the past decade and will grow its earnings by another 20% in 2008. Despite the recent acquisition of two businesses from Amec, the company will end the year with around £100m of cash. We believe the medium term drivers for the business are robust and that profit forecasts are well underpinned by conservative accounting.

We are confident that these holdings will ultimately generate significant returns. However, until visibility improves, volatility is likely to remain high. As ever, success will depend on rigorous fundamental analysis that will allow us to identify those stocks best placed to outperform.