Emma Wall: Hello and welcome to the Morningstar series, 'Why Should I Invest with you?' I'm Emma Wall and here with me today is Harry Nimmo, Manager of the Standard Life UK Smaller Companies Trust (SLS).
Hello Harry.
Harry Nimmo: Hi.
Wall: So, you've run the Standard Life UK Smaller Companies Trust for a long time, highly regarded by our research team.
Nimmo: Thank you.
Wall: You have a couple of systems that you have in place to make sure that the stocks that you are picking are the ones that are going to deliver returns to investors, don't you? There are processes I believe, six steps?
Nimmo: I call them six rules for investing in smaller companies and I've been running the Standard Life Smaller Companies Trust since 2003, so it's had 11 year to wash through. So, shall I just rattle through them?
Wall: Yeah, absolutely.
Nimmo: Okay. The first one; growth is important for smaller companies. Smaller companies need to become large, they need growth and we are talking about profits growth and ultimately, dividend growth is very important. So, growth is important.
Secondly, concentrate your efforts. There are 700 companies to choose from, your best to focus on the specific requirements, the factors that you consider will go together to help a share outperform and we use a screening process, we call that the matrix, so that concentrates our efforts and keeps us true to our process.
Number three; you go for quality, quality businesses and I mean, visibility of earnings, cash flows, Z-scores is a measure we look at a lot. I have always found that actually risk, low risk can mean better returns. Actually high risk doesn't mean better returns. In my book, in smaller companies, it means poorer returns in the long run.
Running your winners is important. In smaller companies it's not about taking a 10% or a 20% turn, it's about holding great companies for extended periods, for hundreds of percent return and a good example from our funds are things like ASOS (ASC), things like Hargreaves Lansdown (HL.), Ted Baker (TED) that have worked for many, many years. So, running your winners is important.
Management longevity; we try and spot these business builder who are often founders of businesses. Indeed, I would say out of our top 20 stocks 8 of the companies will be run by founders and the bulk of the rest will be run by individual managers who have built these businesses over 10 years or more.
The other final point is don't get obsessed with valuation. Don't just buy low P/Es and high yields. That's quite often a sign that there is something going wrong with the company and there is a profit warning around the corner.
Wall: These rules are very specific to smaller companies though, in particular things like running your winners. If you were running a large-cap fund, I think people will be tempted to say, oh, I'll trim off the excess gains and I'll reinvest them in another company. But with smaller companies just because they have had exponential growth doesn't mean they can't expect that again?
Nimmo: Exactly. I think there is definitely truth in what you say. With the very largest companies actually the growth has run out from many of them. So, you have to possibly time your investments, that's not my business. I'm trying to buy tomorrow's larger companies today and within specific niches and there are thousands of niches out there, a small company can growth to many times its size in say 10 years.
Wall: What about the rules for selling a stock because you have mentioned that you have 20% turnover, so there must be triggers there for you to let things go?
Nimmo: Three reasons why we would sell a stock. I mentioned earlier that we have a stock selection screening process, we call the matrix. So, it's a weighted system. We look at about a dozen factors. So, when we are looking at stocks we buy high scores and we sell low scores. So, when our screening process moves into strongly negative territory, if it's in the bottom 15% of scores, that's a sell signal. So, a company that no longer complies with our investment criteria.
The other reason we sell is if a share becomes more than 5% of the total portfolio, that's too risky, too many eggs in one basket. And the other reason we would sell if it moved decisively out of smaller companies' territory. For instance, if it got itself into the FTSE 100, we really should be selling that kind of stock. We look to keep 80% of our assets at the bottom 10% of the market by market capitalization and that is a market capitalization below about £1.3 billion now.
Wall: Harry, thank you very much.
Nimmo: Thank you.
Wall: This is Emma Wall for Morningstar. Thank you for watching.
