While some investors are worried earnings growth will not support the re-rating of the last two years, the manager of the £871m Old Mutual Smaller Companies fund is confident he will still be able to make strong returns this year. “It’s fair to say the very easy money has been made, but I still feel positive looking forward for UK small caps,” he said. “A lot in 2014 still depends on earnings growth, but I think that will come.”
“We are seeing the first meaningful reopening of the IPO market since the credit crunch, which will prove a massive boost for small caps. I’m expecting a pivotal year – one that will also enable us to benefit from a pool of stocks being refreshed by a vigorous supply of new companies as well.”
“I also feel confident because we are seeing the UK surprise on the upside, with deeper growth coming through than in the rest of world, particularly the developing world.”
“The overall backdrop is a pretty positive one, but more importantly in the small cap space we have relatively immature companies that have a higher latent potential for growth.”
Old Mutual Smaller Companies has outperformed its sector and benchmark over three years, returning 70.25 per cent compared with a sector average of 60.2 per cent and 67.37 per cent from the Numis Smaller Companies index.
Performance of fund vs sector and benchmark over 3yrs
Source: FE Analytics
The manager is also ahead over one and 10 years, though lags behind slightly over five.
Nickols’ bullish outlook for the small cap market is tempered by a belief that some fund managers will get hurt by the overvaluation of newly floated companies.
“Pricing will become more attractive for fund managers who are already lining up to participate in the coming IPOs,” he explained.
“There is a risk that people might get a bit carried away and that some stocks will get overpriced, but for the most part I think we have an array of interesting and well valued businesses.”
Nickols bought into Boohoo when it was floated earlier this month, but was not interested in AO.
Boohoo and AO are both recently launched internet retailers, with the former a competitor for ASOS and the latter focusing on electrical goods. Both have had strong starts to trading but have since fallen from their launch price.
Performance of stock since floatation
Source: FE Analytics
Old Mutual Smaller Companies saw significant inflows in 2013, a trend that has continued so far in 2014. Nickols says net inflows year-to-date have already topped £40m, pushing total assets under management towards the £900m mark.
However, the manager says he's not worried about liquidity and is not expecting to have to soft-close the fund any time soon, as its low concentration of stocks and active style will allow it to grow and retain flexibility.
“It’s on the table but not imminent anytime soon,” he said.
While Nickols remains relaxed, some UK Smaller Companies managers have recently warned that there could be a new bubble inflating, particularly in tech.
Henderson’s Stuart O’Gorman says many early-stage tech stocks have now reached valuations that bear little resemblance to their earnings potential.