Bullas says that the year began with a strong sense of optimism which has been hit by a disappointing earnings season. The manager adds that 2014 is far more likely to see a sustained recovery, but he warns that investors are still getting ahead of themselves in their expectations, and forecasts are still too optimistic.
"The market has really come a long way in the past year to date, but what we saw in the March reporting period was that the business environment is still very tough," he said.
"The market got excited at the start of the year about a potential recovery. That has been pushed to the right and has probably been delayed by a year now."
"Quarter one has been very difficult, and two and three are likely to be equally so; we are now looking at the end of ’13 for a recovery and ’14 looks better."
"We are still cautious. Markets have had a great run."
"Looking at earnings growth and profit forecasts, as a whole the market is looking at 4 per cent earnings growth in 2013 and 15 per cent in 2014, which I think is a little bit high."
"There’s risk in the earnings numbers and analysts need to rein in expectations. Eight to 10 per cent growth is more what I would expect for next year."
The manager warns that his forecasts are built on the assumption that progress on the continent continues.
"That’s based on a slow recovery in the EU and a recovery in the US, so we feel the theme is that the recovery has been delayed."
Bullas and his co-manager Paul Spencer took over the Franklin UK Smaller Companies fund in June of last year; the portfolio was previously known as the Rensburg UK Smaller Companies Trust.
The managers embarked on an aggressive reconstruction plan, ditching 30 out of the 59 stocks in just two months.
Bullas says that one of the main changes they made was to rid the fund of the mining stocks that had been weighing it down and that they could not easily value; many of the companies in the sector were dependent on single assets or even single mines.
The fund was revamped by 1 September, according to the manager, and data from FE Analytics shows it has outperformed the sector since then, returning 23.28 per cent compared with the 17.65 per cent of the average UK Smaller Companies fund.
Performance of fund vs sector and index since 1 Sep
Source: FE Analytics
The fund’s returns are slightly ahead of the Numis ex IT index it takes as a benchmark, which has made 20.78 per cent over the period.
The index has been on a good run, making 21.05 per cent over the past year compared with 14.43 per cent from the FTSE All Share.
Bullas says that he still thinks the lower end of the market is attractively valued, even after such a strong period.
"The small cap market, in particular the Numis index, had a stonking year last year, up 32 per cent, but a large part of the movement came from the re-rating of the market."
"It came from such a low base because there was such a massive valuation discount between the small caps and the large caps."
"I still think after the move that valuations are looking reasonable."
Bullas explains that he and Spencer strip out the volatile resources sector and the financial sector from the indices before valuing them, to make it more of a level playing field.
The result is that the FTSE All Share is trading on 13.6x earnings, but smaller companies on 11x earnings, therefore still on a 24 per cent discount to the market as a whole.
The mid cap index, however, is on 14.6x earnings, which is a substantial premium to the rest of the market, and the Numis ex IT index is on 13.3x thanks to its high weighting to the FTSE 250 index.
Franklin UK Smaller Companies has benefited from the strong mid cap surge that has seen it reach these higher valuations.
The managers have bought into Bovis as one way to play the recovery in the housebuilding sector, but they have also added £100m small cap company Topps Tiles, a more indirect method of benefiting from the trend.
The fund is still only £20m in size, and the managers are hoping to attract new money with the dramatic improvement in performance that the fund has shown since they took over.
Bullas concentrates more on the smaller end of the market and Spencer on the larger end.
Spencer has proved his expertise in this area on the Franklin UK Mid Cap fund, which is top quartile in the IMA UK All Companies sector over one, three, five and 10 years, benefiting from the strong performance of the FTSE 250 over this time.
The fund is the top performer in its sector over 10 years, returning 464.37 per cent.
However, in a recent article FE Trustnet looked at the importance of measuring funds against their peers rather than their sector average.
The mid cap fund still impresses on these criteria, however, as the FTSE 250 has made just 341.76 per cent over the same time.
Performance of fund vs sector and index over 10yrs
Source: FE Analytics
Both funds require minimum initial investments of £1,000. The ongoing charges are 1.7 per cent on the smaller companies fund and 1.58 per cent on the mid cap fund.