Big Love for a Small-Cap Manager

THE WEEK: Morningstar columnist Rodney Hobson discusses his infatuation with small-cap fund manager Neil Hermon and bemoans the current state of RBS and Lloyds

Rodney Hobson 1 March, 2013 | 3:21PM
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Climbing a Smouldering Volcano

Once again the euro-crisis, rumbling along like a volcano, has erupted and once again stock markets have crept back. February has been yet another positive month for shares with a gain of 1.3%, more than you can get in an entire year in a savings account.

There is growing evidence that the economic outlook worldwide is in slightly better shape this year than it was in 2012. There is a realisation that equities are still quite cheap

The fault lines will send hot ash flying from time to time but the message remains that the potential upside of equities is greater than the potential fallout from another crash, especially after the mildly encouraging news that earlier official estimates for 2012 GDP have been upgraded in the UK and US.

I was reassured to discover this week that Neil Hermon, head of pan-European smaller companies at Henderson Global Investors, takes a similar line. Although he is conscious of the eurozone difficulties, the US fiscal cliff and a slowdown in China, he thinks that the economic indicators are geared up for global growth.

He says: ‘There is growing evidence that the economic outlook worldwide is in slightly better shape this year than it was in 2012. There is a realisation that equities are still quite cheap.’

I respect Hermon’s views, as he has been a pretty successful operator since he took the reins at the Henderson Smaller Companies Trust (HSL) in November 2002. The Bronze-rated trust invests in London Stock Exchange quoted companies outside the FTSE 100 index and it has outperformed the benchmark Numis Smaller Companies Index in eight of the past nine financial years.

What I like about Hermon is that, despite the inevitable pressures there are on fund managers to outperform relentlessly, he takes the same attitude that I take:

  • He looks for companies paying dividends. About 85% of his trust’s holdings pay dividends.
  • He takes a long term attitude to investing, typically holding shares for five years.
  • He takes a bottom-up approach, looking for promising individual companies rather than sectors.
  • He makes sure that his portfolio is not over-concentrated in any one company or sector.
  • He is prepared to walk away from a possible investment that catches his eye if he feels that it does not represent good value.


That’s pretty much all common sense but a lot of individual investors fail to follow these simple rules. Of course, Hermon does have an advantage over most of us in that he can talk to more than 400 companies every year, but we can all follow his 'four Ms' investment strategy: a sensible business Model; strong Management; enough Money on the balance sheet with a healthy cash flow; and Momentum in earnings.

Currently the trust is overweight in industrials, particularly electronics and electrical equipment, and in companies with global markets. It is underweight in retailers with notable exceptions in Carphone Warehouse Group (CPW) and Ted Baker (TED).

Two of Hermon’s five largest holdings are in house-building: Bellway (BWY) and Taylor Wimpey (TW.). He says: ‘The UK housing market has been reasonably stable for the past three years. House prices have been flat but are showing signs of improving. The government is making significant strides in boosting the housing market and recognises its role in revitalising the UK economy. In the next 12 months it will be a good place to be.’

Investors should note that he does not display any such enthusiasm for commercial property, which he feels does not offer value.

As a shareholder in Taylor Wimpey and also in Barratt Developments (BDEV), I personally feel that the best opportunities in house-building are long since gone but I would certainly not think of selling any holdings in the sector at this stage.

I do not normally suggest that readers of this column should put money into investment trusts as I encourage private investors to back their own judgement. However, if you are looking for a way into smaller companies and want to spread risk right from the start, you could do worse than put your trust Henderson Smaller Companies.

Shares in the trust are currently trading at a 16% discount to the value of assets held, which in my view, is quite ridiculous.

Dark Light

A hospital patient who went through a near death experience some years ago described what he saw as a ‘dark light’. The banks are still coming out of their near-death experience but they are seeing a similar phenomenon.

Royal Bank of Scotland's (RBS) chief executive Stephen Hester can see light at the end of the tunnel despite announcing losses of £5.2 billion for 2012. This announcement was followed by a £570 million loss at Lloyds Banking Group (LLOY) for the 2012 year. Hester reckons that RBS is well on the way to becoming a normal bank and he has a point. Lloyds is on a similar path.

What is holding them back is the ever mounting bill for mis-selling and other misdemeanours – victims may prefer the word "frauds". Hester believes that the days of reckoning are coming to a close and that 2012 will prove to be the last year of monster provisions, for RBS at least.

The banks have shown a great propensity for inventing disastrous financial wheezes so one cannot entirely rule out some other bombshell emerging in the future. The growth of the compliance industry, far from preventing unacceptable behaviour, has proved to be a haven for box-ticking miscreants.

Any investor thinking of getting into either of these banks had better be prepared to play the long game. It will be August before we get interim results proving or disproving Hestor’s claims and probably a long time after that before the government has dumped all of its 82% stake in RBS and 40% in Lloyds, depressing their share prices along the way.

We shall see the start of the government sell-off next year – unless there is another blinding flash of dark light.

Rodney Hobson is a long-term investor commenting on his own portfolio; his comments are for informational purposes only and should not be construed as investment advice.

Market Performance: February 25 - March 1

FTSE 100 Index: +0.68%
FTSE 250 Index: +0.60%
FTSE All Share: +0.66%
FTSE Small Cap: +0.52%
FTSE AIM 100: -1.28%
FTSE Fledgling: +1.20%

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The information contained within is for educational and informational purposes ONLY. It is not intended nor should it be considered an invitation or inducement to buy or sell a security or securities noted within nor should it be viewed as a communication intended to persuade or incite you to buy or sell security or securities noted within. Any commentary provided is the opinion of the author and should not be considered a personalised recommendation. The information contained within should not be a person's sole basis for making an investment decision. Please contact your financial professional before making an investment decision.

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Securities Mentioned in Article

Security NamePriceChange (%)Morningstar
Rating
Barratt Developments PLC475.90 GBX-2.04Rating
Bellway PLC2,221.00 GBX-3.73
Dixons Carphone PLC78.80 GBX-6.64
Henderson Smaller Companies Ord840.98 GBX-1.64Rating
Lloyds Banking Group PLC43.26 GBX-1.23Rating
NatWest Group PLC208.90 GBX-1.28Rating
Taylor Wimpey PLC123.20 GBX-2.03
Ted Baker PLC137.86 GBX-2.64

About Author

Rodney Hobson

Rodney Hobson  is a columnist for Morningstar.co.uk and author of several investing books, including The Dividend Investor and How to Build a Share Portfolio.