Small companies equal big returns

By Alan O'sullivan
Updated: 12:32 EDT, 12 September 2007

Small companies involved in healthcare and social services have allowed one City fund manager to weather recent stock market storms and post some of the best returns among his peers over the past year.

Global stock markets spent a large part of last year recovering from a major correction caused by commodity prices, only to be racked again this year by volatility in China and a more recent global credit crisis.

Yet many companies in the healthcare and support services sectors have suffered less from global economic instability than others, such as the financial services industry, according to Dan Nickols, manager of the £570 million Old Mutual UK Select Smaller Companies fund.

Nickols' preference for these 'structural' companies – which are not as vulnerable to the state of the economy because they have strong, guaranteed contract lists – has cemented his reputation over the past year as a top performer.

The small companies fund sector has done relatively well over the past few years, but Nickols even outshone the majority of these over the past year by coming second in the group of 51 funds.

If you had invested in his fund a year ago, you would have received a 29.7% return at the end of August, in comparison to the average fund's 19.1%.

Some of the companies that helped him to bring in these returns include the UK's largest provider of care homes and long-term care beds, Southern Cross Healthcare, which takes up approximately 2% of his fund.

The group more than doubled its size in 2005 with two large acquisitions and now has more than 570 care homes, with over 28,000 beds and 33,000 staff.

Southern Cross's fortunes are based on the fact that the UK has a rapidly ageing population. There was a 6% rise in the over-85 age group in the year to the middle of 2006, boosting the average age of Britons to 39 compared with 34 in 1971, according to recent statistics by the Office of National Statistics.

'This means there will be a on-going need for nursing homes,' Nickols said. 'It's a constant need that has to be addressed.'

As demand is currently exceeding supply, the guaranteed custom this creates means that the company can quickly recover from volatile market conditions.

Although its share price took a hit in mid-August at the height of market volatility, it has quickly recuperated over the past month to recover half of the ground it lost during the fall in markets. It is currently trading at 507p a share, up from approximately 450p a month ago.

Another name that has recovered well is home services company Connaught, which has been widely tipped as a recommended 'buy'. The company's success is built on the government's Decent Homes Initiative, its pledge to renovate the country's 5.5m or so council houses.

Connaught has a market share currently of only 3%, which means it has further to grow and could generate high returns for those who invest early.

The company has a long list of contracts in an industry that is just beginning to take off, Nickols adds, as well as a secondary business involved in checking safety standards in commercial buildings.

'Outsourcing of housing provision from the public to the private sector is in its infancy. It's a huge sector and as its in an early stage of development, there are great opportunities for those who recognise them,' he said.

Connaught's share price is currently at 328p, down from 340p at the beginning of the month, but this represents a dramatic recovery from a low of 300p in August.

Nickols dismisses claims that the value of smaller companies in the UK is diminishing after three years of posting strong returns relative to medium-sized companies and the market's largest players.

The share prices of smaller companies are currently trading at a 22% premium to the FTSE All-Share, he said, 'the highest they have been since the late 80s'.

This means that they have grown expensive and may contain little extra value. However he points out that smaller companies on a global scale have expanded much faster, which means UK companies may have some more room to grow.

'As we stand in the shadow of the credit crisis, the evidence shows that the economic environment is still supportive of small caps (companies with a small capitalisation),' he said. 'In terms of global GDP, they are still quite strong.

'Global GDP is growing at approximately 4-4.5% a year and the UK is growing at around 2.5%. There are some obstacles, but we are already at an interest rate peak in the UK and the overseas element that could give cause for concern, inflation, seems to be under control,' he added.

'One thing I think I've proved is that smaller companies still punch above their weight.'