Nickols, who runs the Old Mutual UK Smaller Companies and UK Smaller Companies Focus funds, says that though pure stock-pickers may deliver high returns over short bursts, their lack of focus on the macro means that they are susceptible to steep falls when newsflow takes a turn for the worst.
He believes combining both approaches is the only way to achieve consistency over the long-run.
“We mix top down and bottom up analysis, not just for its own sake, but because by using that balance you deliver consistent performance from one year to the next,” he said.
“I am clearly conscious that some of my competitors will have a stellar year every so often, but I question how much that is worth if that stellar performance is followed by a pretty poor one,” he added.
Our data shows there are a number of funds in the IMA UK Smaller Companies sector which have followed a stellar year with one to forget.
One example is Deryck Noble-Nesbitt’s Close Special Situations fund. It returned a massive 246.78 per cent in 2009, during the rebound from the financial crisis. However, the fund has been bottom quartile over every calendar year since.
Year-on-year performance of funds versus sector and index 2007-2012
| Name | 2013 | 2012 | 2011 | 2010 | 2009 | 2008 | 2007 |
|---|---|---|---|---|---|---|---|
| Old Mutual - UK Smaller Companies | 18.73 | 27.12 | -8.86 | 34.06 | 39.24 | -32.78 | -0.01 |
| Close - Special Situations | -1.5 | -4.25 | -14.48 | 24.03 | 246.87 | -57.26 | -4.82 |
| IMA UK Smaller Companies | 13.63 | 22.6 | -9.04 | 31.56 | 50.18 | -40.54 | -6.28 |
| NUMIS NSCI Ex Investment Companies | 17.78 | 29.94 | -9.13 | 28.49 | 60.73 | -40.83 | -8.33 |
Source: FE Analytics
This includes a disastrous 2011, when it lost 14.48 per cent.
In contrast, Nickols’ £589.8m Old Mutual UK Smaller Companies fund has been one of the most consistent fund’s in the sector since its launch in September 2001. According to FE Analytics, it has been a top quartile performer over one, three, five and 10 year periods.
It has been the third best performing UK small cap fund over the last decade with returns of 423.03 per cent. It has beaten its benchmark – the Numis NSCI ex Investment Companies index – by 127 percentage points in the process.
Performance of fund versus sector and index over 10yrs
Source: FE Analytics
Those returns stem from the fact that his fund, except for 2009, has beaten the sector and the index in every calendar over the last decade. The fund returned 39.24 per cent in 2009, but this wasn’t enough to see it break out of the fourth quartile of its sector.
He says the fund’s relative underperformance in 2009 was due to his conservative stance in the aftermath of the Lehman crash.
“I hope people feel I am as upfront about the things that I haven’t done as well over the years,” he said.
“Our underperformance in 2009 really goes back to our interpretation of the top down environment towards the back end of 2008. If you cast your mind back that was a period where I think the idea that the financial system was facing some sort of systemic failure, was a tangible one.”
“We positioned the funs very defensively as a result.”
“With the benefit of hindsight, it may sound pretty curious now, but the portfolio was orientated towards areas of government spend that we thought would be the most resilient in a very difficult financial environment.”
“The fund was skewed towards defensives, support services and aerospace and defence companies. The problem in 2009 was that in March there was co-ordinated government and central bank action to reflate the financial system.”
“Defensives had led the market, but there was switch in leadership to highly cyclical and in some cases, highly leveraged companies,” he added.
Though Nickols re-positioned the portfolio in the latter stages of the year, the fund was destined to be bottom quartile as “the damage had already been done.”
The manager says the fund’s process starts with macro analysis followed by in-depth micro examination. Nickols’ team analyse economic growth, interest cycles, extreme events and industry trends.
He says that looking at these factors determines which sectors he adds or reduces exposure to, be it those with a defensive or cyclical focus.
“After that top down work, we back that up with detailed bottom up analysis. Given the inefficiency of the UK small cap market we believe there are real opportunities to add value via stock selection,” Nickols explained.
He says there are three brackets or themes within his fund. The first is “structural growth” companies, which he says can deliver mid to high teen earnings growth in a low GDP growth environment. He points to multi-utility company Telecom – his 10th largest holding - as a good example.
“The second theme is “total return”, so companies that have reasonable rates of earnings growth but have high or rising dividends and can offer investors special cash returns,” he said.
He counts asset manager Jupiter as a company that fits this definition.
“The third theme we are pursuing in the portfolio is “special situations.” Very often this has something to do with a change in market conditions,” he said.
Nickols says that UK house builders are an example of companies in a “special situation.” However, he points to US focused manufacturing rental company Ashtead – his largest holding – as the best example, as it is set to benefit from “an incipient recovery in the US housing market.”
Old Mutual UK Smaller Companies has an ongoing charges figure (OCF) of 1.94 per cent and requires a minimum investment of £1,000.