Mark Dampier: Growth at smaller firms allows funds to diversify

Like a good football scout I am always looking for new talent that might become a Premier League star of tomorrow. Thomas Moore might be one such fund manager. He took over Standard Life UK Equity Income Unconstrained fund at the start of 2009 after it had endured a terrible time. He has since turned its performance round, and is in his fourth year of managing the fund.

The fund is in the UK equity income sector where famous names such as Neil Woodford, Anthony Nutt and Bill Mott also reside. There is little point in trying to take these household names head on. They all have good records of growing both income and capital for investors, so how does he differentiate the fund?

As the name suggests, it is a focused portfolio of best ideas. The top 10 positions account for about 40 per cent, which means each one makes a real difference to performance. It's an approach I tend to favour as it means a fund has greater capacity to outperform in the hands of a good manager, though it does tend to increase volatility. It is by examining these top holdings that you find the fund is doing something different to most others in the sector.

The top holding is Petrofac, which perhaps typifies what Mr Moore is looking for. The share yields less than the market but the company has more than trebled its dividend since 2007. He doesn't target a high yield today, instead looking for growing companies where dividends are rising strongly from a lower base. Other holdings in the top 10 include publishing and events group Informa, packaging specialist DS Smith, and aerospace engineer Senior.

These are all shares not typically found in the top 10 of well-known funds in the sector. They tend to focus on recognised blue chips such as Shell and GlaxoSmithKline. Therefore, Mr Moore sees his fund as a complement rather than a competitor to Neil Woodford and the like. I think this is right. There is little point in buying two funds that have very similar holdings.

Mr Moore is well supported by the Standard Life UK equity team and, in particular, their proprietary stock screening system known as the Matrix. This system analyses a number of important factors such as valuation, earnings momentum and balance sheet quality, ranking the shares in order of preference. The fund managers can then prioritise further research accordingly. Although the system tends to not work so well around market inflection points it has done a good job over the longer term.

You might think it has been plain sailing due to the timing of his appointment to the fund. After all, the market has risen substantially since. However, we have seen a succession of short, sharp cycles over the last couple of years as risk appetite has risen and fallen. Many of the fund's holdings are perceived to be highly economically sensitive, and the third quarter of 2011 was particularly hard on the fund. These areas, especially smaller companies, suffered. In contrast, more defensive stocks such as pharmaceuticals came to the fore, favouring the more established managers with exposure to these areas. However, since the start of the year it is one of the best performing funds in the sector, up by over 10 per cent.

This illustrates how it isn't closely correlated with others in the equity income sector, making it useful in terms of constructing an income producing portfolio. Unlike many others it is small and nimble, able to take meaningful positions in smaller and medium-sized companies. This allows income investors to diversify and potentially benefit from the higher levels of growth among smaller firms. Mr Moore is still quite young, but with a team of seasoned professionals around him such as Harry Nimmo he has great experience to draw upon. I certainly hope Mr Moore can continue to perform well as the active fund industry needs its future champions.

Mark Dampier is head of research at Hargreaves Lansdown, the asset manager, financial adviser and stockbroker. For more details about the funds included in this column, visit www.hl.co.uk/independent