Standard Life UK Smaller Companies good at chosen vocation

Muna Abu-Habsa, fund analyst at Morningstar: Harry Nimmo has managed this fund since its launch in 1997 and has consistently applied a diligent investment process over its lifespan, amassing an impressive record. The manager is backed by an experienced UK equity team, whose average tenure at the firm is 10 years. He also heads a dedicated UK small-cap equity desk to meet the need for additional analytical resources for covering smaller companies. Standard Life combines fund management and research roles and Nimmo has analytical responsibilities in the small-cap team covering nine industries.

The starting point for Nimmo is a quantitative screening tool which evaluates stocks on ten factors relating to share price performance and attempts to identify improving or deteriorating situations which arguably are unrecognised by the market. It screens the fund’s investible universe of FTSE 350 and FTSE Small-Cap stocks to those worthy of further qualitative analysis. For this portfolio, Nimmo assesses the market share, barriers to entry and pricing power of these companies and favours companies with proven business models and recurring revenues.

Nimmo’s process yields a portfolio that is highly skewed towards dividend-paying growth stocks such as Connaught or Dignity, and he will move up the cap ladder a bit more than some of his rivals (the fund's mid-cap stake was double the category average at the end of June 2008). He aims to hold these stocks until they have achieved their full growth potential and his patience is reflected in the portfolio’s low turnover rate. However, the tilt to growth increases price risk in the portfolio. Stocks with high earnings multiples reflect optimistic expectations and if such expectations are not met this can weigh heavily on their performance. Thus, in the short term the fund can experience spells of higher volatility than its average peer in the Morningstar UK Small-Cap Equity category. Overall, though, Nimmo has managed to keep a lid on volatility which lessens our concern.

This fund has generally exhibited greater resilience than the market during downturns and tended to outperform in more risk-averse environments. In 2007, for example, it ended the year in its category's top quartile, losing just 2.4% compared with 7% by its average peer. Over the long term, Nimmo has produced strong returns. Between its launch June 1997 and October 2008, the fund posted gains of 9.8% per annum, on an annualised basis, representing an outperformance of 4.8 percentage points over its average category rival.

We have seen Nimmo in action over a number of market cycles and are also encouraged by his personal investment in the fund, which demonstrates conviction in his strategy and aligns his interests with those of shareholders'. Granted, many risks are inherent to investing in this segment of the market, but for those seeking exposure to UK smaller companies, we believe this fund is a compelling choice.

Strategy

In keeping with the UK equity team, Nimmo uses a quantitative screening process across the FTSE 350 and Small-Cap indices to narrow down the fund’s investible universe. It assesses stocks on ten factors including value, momentum (price and earnings) and balance sheet-related variables that attempt to identify improving or deteriorating situations which are unrecognised by the market. The managers take the high-ranking stocks from the screen and undertake more in-depth fundamental analysis. This includes identifying the key growth drivers for each company and how changes in these will impact their view on the company. Managers will conduct industry research in the areas in which the company operates, its products, the key drivers of its revenue and any potential threats to the business. Nimmo is drawn to tomorrow's larger companies. He assesses market share, barriers to entry and pricing power of these companies and favours dividend-paying growth stocks of companies with proven business models and recurring revenues.

Individual stocks are capped at 5%, the top 10 holdings combined must not exceed 30% and AIM stocks are limited to 25%. Constraints are also applied to the sector level, where a position can be 8% overweight a sector relative to its benchmark, so long as this weighting remains less than double.

Management

Standard Life veteran Harry Nimmo joined the firm as an investment analyst over twenty years ago. He became an investment manager in 1993 and has managed this fund since its inception in 1997. The average tenure in the UK equity team, of which Nimmo is part, is 14 years, with 10 of these at Standard Life. Nimmo also heads a dedicated UK small-cap desk of three investment directors, collectively running £1.3billion in assets. Standard Life combines the fund management and research roles, with each manager also having sector responsibilities. Nimmo covers chemicals, electricity, electronic & electrical equipment, food producers, food & drug retailers, household goods, leisure goods, personal goods, media and pharmaceuticals & biotechnology. He boasts 23 years of investment experience, 15 of which has been dedicated to investing in smaller companies.

Nimmo invests in both this fund and the Standard Life UK Smaller Companies investment trust and we are glad to see this alignment of his interests with his shareholders' coupled with conviction in the strategy.