Many managers and retail investors follow a value strategy that involves looking for companies that are out of favour by the market, but Rowsell, and Nimmo (pictured), take the opposite approach.
Buying stocks that are doing well a so-called “momentum” approach – is more likely to lead to outperformance in the long run, he explains. “The value approach is higher risk and more volatile,” he said. “In the smaller companies you are increasing the risk of buying s stock that falls considerably or goes bust.”
“Momentum can be a dirty word, but we mean if you identify really good companies they can continue to be good companies in the future. They don’t often become bad.”
Rowsell explains that his universe of stocks is screened using Standard Life’s proprietary Matrix software which looks at forward share price momentum among other factors.
Many investors worry that by buying into stock stories that have already run for some time they are likely to miss out on the best of the growth, but Rowsell says this should not be concerning.
“The market has a relatively short investment horizon and it only prices in the next one to two years,” he said. “The market will only price in future growth steadily.”
This latter point implies that the efficient market hypothesis, which holds that share prices reflect all public information about a stock, is false, as Roswell claims.
The efficient market hypothesis is used by many advocates of a passive approach to investing.
The £206m Standard Life Global Smaller Companies fund was launched in January 2012 with FE Alpha Manager Harry Nimmo’s oversight.
The idea was to apply the latter’s strategy on a global spectrum of companies. Rowsell describes it as a “quality growth” approach.
It involves avoiding companies that are too cyclical in their earnings, he explains, and looking for those with a competitive advantage.
Nimmo’s outstanding track record - he is in top place for returns among UK managers with a 10-year track record – is built on sticking to this approach in all conditions.
Data from FE Analytics shows that the fund has had an excellent start to its life, returning 45.52 per cent as the MSCI World Small Cap index has risen 34.86 per cent.
Performance of fund versus sector and benchmark
Source: FE Analytics
The fund has an average market cap of £2.3bn, making it larger than Nimmo’s, which has an average of £1.5bn. It also has slightly higher turnover.
The largest holding is Telecom Plus, which also features at the top of the list of the soft-closed Standard Life UK Smaller Companies fund headed by Nimmo.
The company provides cheaper, consolidated utility bills to consumers, playing into a topical social anxiety.
It certainly has momentum behind it, with the share price having appreciated 343.13 per cent over the past three years as the FTSE All Share has made just 27.75 per cent.
Performance of stock versus index over 3yrs
Source: FE Analytics
Other cross-holdings between the UK and global funds include online retailer ASOS, which Harry Nimmo has held since it was a tiny company.
The manager has held on to it as it has grown into a large mid-cap, and Rowsell says this illustrates the approach he takes on the global fund – “running winners”.
Ted Baker is another UK holding which the manager likes and is in the top 10, at 2.5 per cent of the portfolio.
Middleby, an American catering equipment manufacturer is another favourite. Roswell says that afte the screening process threw up the stock, fundamental analysis showed that it was developing innovative new products which showed potential for future growth.
The company sells steamers which use the vapour from the vegetables rather than requiring water, and fryers which recycle and reuse cooking oil.
Many of the stocks that Rowsell has bought contain a technological theme, and are generating their steady growth by this means.
German company Jungheinrich manufactures diggers, but is moving into the field of robotics, which offers potential for huge growth, the manager says.
Wirecard, also German, operates online payment processing systems, while SciQuest helps hospitals in the US procure equipment for lower prices by pooling orders.
One of the other themes in the portfolio is Obamacare. Towers Watson has found a new market in advising employees on workplace insurance, which reforms have made more expensive for companies to deal with themselves.
The Matrix and the momentum strategy it implements draws the manager into sectors and geographies with the wind behind their sails.
Europe is the region showing up the most number of new companies of interest, Rowsell says, while he holds very little in emerging markets and Asia.
The system is sensitive enough to forward estimates not to be too slavish to past good performance, he says, meaning that the fund is able to shift out of areas before they fall off, as emerging markets did last year.
A number of analysts have suggested that the small cap boom could come to an end this year and the valuation gap with large caps close.
Rowsell says he doesn’t believe there will be a period of sustained underperformance.
The last time this was the case was the late 1990s, when a huge amount of retail money flooded the market and went for the larger stocks, he explains.
Performance of indices in 1990s
Source: FE Analytics
Retail investors are just starting to come back into the market now, he says, while the M&A situation favours small caps.
At the end of the ‘90s there was a lot of M&A between large companies, while now the activity that is seen is mainly large caps taking over small caps, supportive of the latter sector.
We are at the mid-point of the cycle for smaller companies, he suggests.