Mark Dampier: Small can be beautiful if you're seeking a bargain

The Analyst

I am always surprised by the extent to which smaller companies are overlooked by investors.

Whether it be on a UK or global level, smaller companies don't feature heavily in many portfolios. But I believe it's an area retail investors should focus on more.

Large, institutional investors such as pension funds and insurance companies are generally unable to invest much in smaller companies. Their sheer size means they simply can't buy the amount of stock they need. Similarly, the fortunes of the world's largest companies are well publicised. Analysts pore over every detail of their accounts and the financial press dedicates many column inches to their prospects. This leaves smaller companies under-researched. Many fund managers don't bother wearing out shoe leather visiting, researching, or understanding these businesses, leaving promising bargains available for those willing to look.

While smaller companies are clearly more volatile, investors have been rewarded for taking the extra risk over the long term. Over the past 10 years, global, smaller companies have significantly outperformed their larger counterparts, returning 237 per cent compared with 141 per cent respectively. Their more volatile nature also means they make excellent vehicles for monthly savings into an ISA or SIPP.

One of our favourite fund managers in this area is Harry Nimmo, who has generated superb returns on the SLI UK Smaller Companies fund since its launch in January 1997. The fund has now reached capacity and is no longer seeking new investment.

The SLI Global Smaller Companies Fund was launched in January 2012 to capture the increasing array of opportunities to be found across the world. Mr Nimmo's role entails overseeing the management of the fund, ensuring his well-rehearsed investment process is adhered to. In terms of stock picking his key focus is on the UK portion where 16 per cent of the fund is invested. The portfolio is co-managed by Alan Rowsell who focuses on the fund's overseas holdings. The pair work closely together in finding the highest-quality stocks to add to the portfolio. It is concentrated with around 57 stocks at present which allows each to have a significant impact on performance, but it is higher risk.

Mr Nimmo's emphasis on quality has worked well in the UK. He looks to buy tomorrow's larger companies today. This means he prefers those with a proven business model, ideally generating recurring revenue to help the company prosper through good times and bad. He also likes those able to raise prices without seeing a drop in demand and those operating in areas with barriers to entry, making it harder for the competition to swoop in and take market share.

A large part of Mr Nimmo's success over the long term can be attributed to his willingness to hold onto his winners, participating in their success as they grow. This fund has had a number of successes in the US where around 38 per cent of the portfolio is invested. Examples include Maximus which operates a variety of services for government human and health programmes in the US. The business has seen increasing demand for its services especially as the government seeks to outsource as a way of cutting the budget deficit.

Other holdings include Amtrust, an insurance company whose business has continued to grow, and Polaris, which has seen sales increase as it has introduced exciting new products to its off-road vehicle and motorcycle franchise.

Initial results have been encouraging with the fund rising by 25.6 per cent since launch compared with the average in the sector which has returned 19.4 per cent. Significant contributors to performance also include Cosmos Pharmaceuticals, a Japanese discount pharmaceutical chain, which has been held in the portfolio since launch. The company's discount business model enables it to take market share from the competition and they it has now embarked on an aggressive expansion plan. The stock has grown to be the largest position in the fund in keeping with the managers' investment philosophy of running their winners and cutting their losers.

The fund seems to have had little publicity since launch which is strange given the quality team and Mr Nimmo's long track record.

For those seeking a long-term investment in under-exploited areas of the market where plenty of anomalies and mispricing's still exist, I believe this fund could be a good place to start.

Mark Dampier is head of research at Hargreaves Lansdown, the asset manager, financial advisor and stockbroker. For more details about the funds included in this column, visit www.hl.co.uk/independent