Companies Can Be Out of Favour For No Reason

VIDEO: Merian UK Smaller Companies fund manager Dan Nickols is picking up shares in unloved consumer companies as the UK remains firmly out of favour with investors

Holly Black 1 July, 2019 | 2:44PM
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Holly Black: Welcome to the Morningstar series, "Why Should I Invest With You?" I'm Holly Black. With me today is Dan Nickols. He is Manager of the Merian UK Smaller Companies Fund.

Welcome to the studio.

Daniel Nickols: Thank you.

Black: So, what are you up to in the UK Smaller Companies Fund? What does that aim to do?

Nickols: Over the long term the opportunity really is to invest in I think a very exciting part of the UK stock market. So, if we think about our opportunity set, even for a desk like ours, which manages quite a lot of money, there are around 700 stocks that we can pick from. I think the real attraction is that many of those companies are actually quite poorly-researched. There's not a lot of research written on them. So, we have had, I think, for many years and continue to have an opportunity to be – well, to get an information edge versus the rest of the market. Over and above that, I think there are two or three other sort of attractions and one of the most compelling of those is the fact that by definition a lot of the companies in our investment universe tend to be quite immature. They are sort of quite early in their corporate lifecycles. So, their latent ability to grow and to grow at a much faster rate than more established businesses can is very much there for us to exploit.

Black: But doesn't that also make them more risky and if they are nascent, more prone to failure?

Nickols: Yeah. I mean, that's a fair observation. But I think, again, that's the sort of the good stock selectors' edge, if you like. It's basically three key things we want to try and find. Firstly, can we find businesses that can deliver sustained above-average growth, so, say, three to five years' worth. So, it's not particularly related to the world or economic cycle, it's factors intrinsic to the company itself. Secondly, and I think this is actually probably the most important dynamic, can we find businesses that we think can deliver unanticipated earnings surprise? And we spend a lot of time delving into market forecasts, understanding how they are made up, comparing that with our own understanding of a company's prospects to try and uncover those opportunities where the possibility of an earnings beat is there to be exploited.

And then, thirdly, can we find businesses that might be re-rated relative to the market. As I say, a lot of the time – or some of the time companies in our space can be mispriced for no particular reason. So, if we can find businesses that maybe could benefit from new management teams or new strategic direction, these are the sort of businesses that can actually enjoy a rerating as well. And frankly, if we can find businesses that have more than one of those characteristics, the investment case can become more powerful still.

Black: So, the UK has been really out of favour in the last few years with Brexit, political uncertainty, we're currently trying to find a new Prime Minister. How does that affect what you are doing?

Nickols: Yeah. We've always run the fund on the basis that we're going to combine top-down thinking with bottom-up stock selection work. In fact, the top-down side of the equation is the starting point of what we do. So, we're always trying to make sure that from a thematic and sector standpoint the funds are positioned in a way it should be able to contend positively with the market environment and the macroeconomic circumstances. So, I think, we've got that framework in place. So, in a nutshell, what have we been doing over the course of the last two, three years and in particular since the referendum back in 2016? We had a deliberate overweight to what I'd characterize as structural growth businesses, in fact, businesses which very often are quite internationally-exposed rather than ones that are more exposed directly to the U.K. economy and that's served us very well.

In the meantime, however, and of late a lot of that sort of UK, particularly the UK consumer-exposed part of the market has fallen so far out of favour that valuations, I think, have become really anomalous there. So, in more recent times over the course of the last three to six months, we've been trying to find ways of just selectively picking up very cheaply-rated UK domestically-orientated businesses that in the fullness of time – and we don't exactly when it's going to happen – but in the fullness of time when we get Brexit clarity, when as I think would be likely in that environment you get sterling beginning to appreciate again from current levels, the sorts of businesses that should be able to benefit from both earnings upgrades as sterling begins to strengthen again and where the currently adverse sentiment will unwind as well and you should get a re-rating among those sorts of businesses as well. So, that's just something we've begun to put in place in the portfolio.

Black: Well, thank you so much for your time. And thanks for joining us.

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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Holly Black  is Senior Editor,


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