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How to make money like FE Alpha Manager Dan Nickols

30 April 2015

Daniel Nickols of Old Mutual Global Investors tells FE Trustnet his golden rules, his investment no-no’s and the stock attributes he thinks are most important.

By Lauren Mason,

Reporter, FE Trustnet

A degree of humility, a combination of top-down analysis and bottom-up stockpicking and being able to follow your gut instincts are just some of the investment rules that Daniel Nickols and his team follow.

The FE Alpha manager is arguably a sound voice of reason, as both his Old Mutual UK Smaller Companies and Old Mutual UK Smaller Companies Focus funds outperformed their average peer over one, three and five years. Over 10 years, Old Mutual UK Smaller Companies is top decile.

Performance of fund vs sector and benchmark over 10yrs

Source: FE Analytics

So what’s the secret behind both funds’ consistently good performances? Nickols and his team have adopted several golden rules when making investment decisions.

 

There are no shortcuts

“If I look back over my career, my better decisions are the ones that my team and I have put the work into – there’s no shortcut,” he said.

“In each individual case you’ve got to have done a very detailed level of work to keep yourself feeling secure and confident that you’ve covered every angle. But you’ve got to do it consistently as well. It’s both hard work and the consistency of hard work.”

The FE Alpha Manager is part of a seven-strong team, who each spend a substantial amount of time thoroughly researching individual stocks.

“The UK small-cap space is an area that is more likely to have pricing anomalies – research on these companies can be very thin,” Nickols explained.

“In our world, there’s a real opportunity to add value by gaining a better understanding of stocks. The general philosophy is that, a lot of the time, the market forecasts that these shares are priced from are quite often wrong in our space, so there’s an opportunity to find that out and exploit it.”

Between them, Nickols and his team attend over 400 meetings with company managers each year as a means of truly getting under the bonnet of each stock.

“We have found that a lot of the time we can identify when things are clearly wrong, and I suppose it’s from that that the added value from stock selection really comes through,” he added.


Admit to mistakes

Nickols believes that managers can quickly scupper their performance by insisting they’re right in the face of contradictory evidence.

“You need to have a degree of humility. Fund managers by nature tend to be quite opinionated and believe that they’re always right, when they’re probably right no more than half the time, so starting with that grasp on reality is quite a healthy thing as well,” he continued.

The manager admits that he has regretted many decisions throughout his investment career, with what he calls his “biggest mistake” occurring during the financial crisis of 2008.

“The world economy looked like it was going down the tubes so I built my portfolio from very defensive footing, the most defensive footing I could find,” Nickols explained.

“So when the central bank and government intervention occurred, there was a very significant risk rally at the start of 2009.”

“Therefore, lots of bombed-out stocks that were the very things you didn’t want to invest in turned out to be the very things you did want to own, following the view that it’s all going to be alright.”

“We got right out of those higher risk stocks at exactly the wrong moment.”

In 2009, Nickol’s UK Smaller Companies fund made positive returns of 40 per cent. However, the Numis Smaller Companies ex Investment Companies index returned over 60 per cent. The fund also underperformed its average peer by more than 10 percentage points.

Performance of fund vs sector and index in 2009

Source: FE Analytics

“It was an unmitigated disaster, seeing as we’re judged by our incentive to ultimately outperform the index,” Nickols added.


Gut instinct cannot be ignored

The star manager believes that investing in inappropriate or unsustainable capital structures for businesses is a common concern among investors. However, he feels this is often prioritised over the importance of trusting gut instinct.

“In the small-cap space, one of the things that is quite difficult to define is the actual personal side of things. Having ‘chemistry’ is much more important than people give credit for.”

Nickols says that if someone pitches a business idea and they simply cannot convince the investor of their potential for success, it’s very likely that their company is not worth investing in.

He said: “It’s not right to name names, but I remember that one guy came into the room, and before he opened his mouth I remember thinking ‘no way’ and it turned out to be an utter disaster.”

“Not before [the stock] doubled and tripled – but it went bust in the end because he was basically a crook. You can only string people along for so long before the market catches up with you.”

However, Nickols believes that using gut instinct should be differentiated from approaching an investment opportunity with an impenetrable guard up.

“At the same time, the number of truly exceptional people I’ve met who have built good businesses from virtually nothing is incredible. It’s really inspirational,” he said.

 

Choose stock attributes carefully

Before investing in a company, Nickols and his team look out for three key features.

“Firstly, the earnings-surprise component. Is there an opportunity for a company to survive the market environment, delivering earnings better than are currently expected?”

“Secondly, can we find companies that can grow at significant above-market rates over the long term?”

The fund manager says these businesses are often characterised as structural growth stocks that offer unique or novel products and services, which will enable them to grow dramatically faster than the wider economy.

“Finally, are there reasons why this company might be re-rated? So for instance, the market might take the view that this company should be valued more highly, that’s often in anticipation of change for the better.”

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Data provided by FE fundinfo. Care has been taken to ensure that the information is correct, but FE fundinfo neither warrants, represents nor guarantees the contents of information, nor does it accept any responsibility for errors, inaccuracies, omissions or any inconsistencies herein. Past performance does not predict future performance, it should not be the main or sole reason for making an investment decision. The value of investments and any income from them can fall as well as rise.