Investors should take note of improving fundamentals and more interesting opportunities across the small-cap space instead of concentrating on “pretty” larger companies, according to Aberdeen Standard’s Harry Nimmo.
While some UK smaller companies funds struggled in 2016 following the EU referendum amid their perceived exposure to the domestic economy, 2017 was a better year for the strategies.
In 2016 Nimmo’s four FE Crown-rated Standard Life UK Smaller Companies Trust recorded a loss of 3.52 per cent. However, last year the £372.5m trust returned to outperformance with a total return of 39.09 per cent, compared with a gain of 19.82 per cent for its benchmark the Numis Smaller Companies index.
Performance of trust vs benchmark & sector in 2017
Source: FE Analytics
Nimmo – who also manages the four FE Crown-rated, open-ended Standard Life Investments UK Smaller Companies fund – said the era of ultra-low interest rates had been a challenge for the strategy given the importance it places on quality in the portfolio, alongside growth and momentum.
“There’s not particular advantage of having a strong balance sheets when interest rates are at a quarter of a per cent,” Nimmo explained. “We have outperformed over the last three-, five- and one-year [periods], but not every year.
“We certainly haven’t been at number one at all [during those periods] because every time there has been a bout of quantitative easing all the cyclicals do well and we do less well.”
“It’s been a little bit less clear cut in the past few years,” he added. “Our best times are in the bear markets: we lose money less quickly than our competition, we had absolutely outstanding years in 2007 and 2008.”
As well as a return to outperformance, the manager said he has seen increasingly attractive opportunities in the small-cap space.
The Standard Life UK Smaller Companies manager said that more recently the firm’s Matrix quantitative screening tool has been generating higher scores for companies in the portfolio, prompting him to add to existing holdings in December.
Aided by a new debt facility, Nimmo raised the amount of gearing to around 9 per cent in the trust to add to holdings.
“It’s partly because we’re seeing our stocks trading very strongly and were seeing very strong Matrix scores for our underlying holdings,” he said.
“If you look at top 10 holdings, all of them are beating expectations when they come in with results, across a wide range of sectors: from healthcare to food & drink, software, even retailers and the support services sector.” 
Standard Life UK Smaller Companies has benefited from the strong performance of several stocks such as UK-listed, Abu Dhabi-based healthcare company NMC Health, which was promoted to the FTSE 100 last year. Other strong performers include Fevertree Drinks, Midwich, First Derivatives and Smart Metering Systems, which all saw double-digit increases in share prices during the latter half of the year.
However, after a fairly active period for the trust in latter part of 2016 and in the wake of the EU referendum, 2017 was much quieter for the manager. 
Nimmo (pictured) said: “I would say, if anything, our turnover is lower than it has ever been. There was higher turnover in the second half of 2016 and the portfolio was adjusted towards companies that had business outside the UK.
“In the past six-to-nine months turnover has reverted to historic levels and remains low. Indeed, holding period right now is an average of five years or more.”
Although Nimmo and the Standard Life UK Smaller Companies Trust remained focus on fundamentals, he said there was a “slight note of caution” surrounding the macroeconomic environment and interest rate hikes.
“I suppose we moved into 2018 with a slightly more cautious mindset, mindful of the interest rate outlook and mindful that deadline for Brexit is near,” said the FE Alpha Manager.
On Brexit, Nimmo remains more positive having taken the earlier decision to move into companies less sensitive to the event.
“I don’t think it’s a foregone conclusion that it’s going to be a terrible thing for UK small-caps [although] many global investors behave like that,” the Aberdeen Standard manager noted.
“We prefer to concentrate on underlying performance of actual holdings in the portfolio and, actually, many of the companies are going to continue to do pretty well regardless of whether we are in the EU or not. They are great businesses and they are growing internationally.”
He added: “The long-term outlook for smaller companies has not changed and they are far more interesting than larger companies in the UK.
“The very largest companies present a pretty story and a dull spectacle. The excitement and growth for the future rests with smaller companies.”
As such, Nimmo is bullish about the prospects for companies in the Alternative Investment Market – AIM – which he said is “better place than it used to be” – and the trust’s exposure to AIM-listed companies now stands at 42 per cent.
Standard Life UK Smaller Companies Trust’s board recently changed the benchmark to the Numis Smaller Companies plus AIM index, something he said trusts are hesitant to do.
“They think generally its bad practice unless it is the right thing to do. We’ve been thinking about this for about a year now,” said the FE Alpha Manager.
“We think the AIM market is significantly better than six or seven years ago. It’s no longer dominated by what we call ‘blue sky’ companies. It’s no longer dominated by resources stocks.
“You have a much broader spread of sector exposure which is positive and there is also a far larger proportion number of AIM stocks paying dividends: 70 per cent are paying dividends, if you go back about six or seven years ago it was 20 per cent or less.”
He added: “I suspect that part of the AIM strength is tax breaks with CGT [capital gains tax] and the like. But I think it is more fundamental than that and that gives me confidence.
“Even if the tax breaks were taken away the AIM market would ultimately, after a short-term blip, continue to be a good venue for investors and that that is in sharp contrast to first 20 years of AIM when it was a downright bad place for investors.”
Since Nimmo took over management of the Standard Life UK Smaller Companies Trust in September 2003, it has returned 1,156.03 per cent compared with a gain of 501.38 per cent for the average IT UK Smaller Companies trust.
Performance of trust vs sector under Nimmo
Source: FE Analytics
The trust is currently trading at a discount to net asset value of 1.8 per cent, according to data from the Association of Investment Companies, and has ongoing charges of 1.08 per cent.