Fund Manager Focus by Jenny Lowe

David Clark, manager of the Ignis UK Smaller Companies fund, believes that widespread pessimism about the prospects for UK smaller companies is unjustified

Ongoing domestic uncertainty and fears over Eurozone instability and forthcoming banking regulation have created a bearish consensus on the prospects for UK smaller companies. Yet David Clark, manager of the Ignis UK Smaller Companies fund, believes that these fears have been significantly overdone.

According to Clark, whose fund has returned 43.8 per cent over the past year, valuations of UK small-caps in certain sectors look particularly attractive: ‘Analysts are becoming more positive, with six consecutive months of earnings upgrades outweighing downgrades. There has also been a resumption of inflows into small-cap funds, meaning that there will be no shortage of buyers of smaller company equity.’

A wide berth
Avoiding stocks sensitive to UK consumer spending and interest rate rises, such as those in the retail sector, Clark has broadened his portfolio to include companies generating profits overseas. One is Indus Gas, which he believes can benefit from India’s increasing demand for electricity, giving energy companies, and the companies providing them with fuel, significant pricing power.

He says, ‘The Indian economy is developing apace, but it could stall without power and infrastructure. Indus Gas provides an interesting mix of oil and gas exploration and production projects in the west of India, which could drive earnings significantly. In the short term, 2010 should see the company generate good news flow, with three new wells set to come online this year, as well as a resource review, which could show decent upgrades.’

Clark has also taken positions in overseas companies such as Great Eastern Energy, a coal-bed methane extractor, Indian Wind, a wind energy provider, and KSK Power Ventur, a power plant developer.

He is invested in globally focused companies providing engineering and consultancy services to the oil industry: ‘The typical life of an oil rig is around 30 years, and currently 38 per cent of rigs in service are over 25 years old. In order to avoid the vast risks and costs associated with using equipment not fit for purpose, the oil majors will soon be making significant investments.’

Petrofac is a key holding in the fund, having seen strong order book growth during 2009. ‘This stock represents compelling value, particularly compared with some of its peers, and its management continues to impress with its ability to successfully execute existing projects and win new ones.’

Healthy returns
Another long-term theme running through the fund is healthcare. While large-cap pharmaceutical stocks wrestle with expiring patents and a lack of pipeline products, Clark says small-cap healthcare companies often demonstrate ‘considerable innovation and growth, in addition to earnings resilience.’

AIM-listed Advanced Medical Solutions (AMS), which makes high-performance polymers for use in advanced wound care dressings, is a prime example. Clark notes, ‘The company’s addressable global market is some US$600 million, which is growing at around 10 to 12 per cent a year. AMS is growing even faster and trades on a p/e of around ten. It is a stock we like in a sector we like.’

While UK companies in general were quick to cut costs in reaction to the credit crisis, these cuts have now largely been made. ‘I find it increasingly difficult to see where the next tranche of profits will be made from many of the larger-cap stocks,’ explains Clark. ‘While bottom-up cost cutting has fed through to date, I see less opportunity in the large-cap arena for top-line growth.

‘However, the small-cap universe offers a far greater pool of stocks and sectors, and is not exposed to the banking, pharmaceutical and oil stocks of the FTSE 100. ‘Small-cap stocks offer a higher growth dynamic, direct domestic exposure to high-growth emerging markets and an abundance of stocks operating in niche areas that should weather economic headwinds,’ he concludes.