Good goods come in small stocks

IRISH institutional fund managers have been missing out on opportunities in the Irish market, preferring to focus on the more glamorous markets in the US and Far East, according to Mr Gervais Williams, who runs the NatWest Irish Smaller Companies fund.

Irish smaller companies, or those below the top 10 in terms of market capitalisation are up to 30 per cent undervalued, Mr Williams says. These include such stocks as DCC, Green Property, Clondalkin, Anglo Irish, Jurys and Ryans Hotels.

Mr Williams also points out that the Irish economic background is without parallel in developed markets. The numbers are easily rattled off - growth of over 7 per cent last year, inflation running below 1.5 per cent and historically low interest rates.

As a result. the Irish market has risen by over 27 per cent over the last 12 months with small companies up by over 30 per cent, compared to 23 per cent rise in the S&P index. And over the last six months Irish smaller companies have been doing even better and have been outperforming the larger stocks. The Davy Small Cap index has risen 23.3 per cent compared to a 14.1 per cent rise in the ISEQ index.

Ironically, he says it is British investors who are benefiting most from the growth in smaller Irish companies as some of the most active fund managers in the sector manage money for British institutions.

In addition, the British public has the opportunity to invest in Irish smaller companies funds while the Irish institutions have so far failed to come up with a similar fund for the Irish public to invest in. Only last week a report from Deloitte and Touche and economic consultants Peter Bacon Associates highlighted the need for the Irish authorities to develop such a fund as well as attract more companies to the market.

Mr Williams points out that companies in the Davy SmallCap index are trading on price earnings ratios of around 10.3 times compared to 14.9 for smaller companies on the London market, while in 1997 the Irish companies are on around 9.6 times compared to 13 times in London.

Part of the reason for the lower ratings in Irish companies is their smaller relative size and the liquidity problems associated with the Irish market. One reason for this is that around 37 per cent of Irish institutional cashflow is going overseas compared to 24 per cent when investment controls were removed in 1989. This amounts to some Pounds 444 million of Irish pension fund and other money going overseas, compared to just Pounds 324 million going into Irish equities.

In comparison almost Pounds 750 million was invested over five years by British and US institutions.

However, Irish fund managers point out that is very risky to have too much money in any one country or sector. Because of the domination of two or three big stocks in Ireland it is possible to end up with up to 5 per cent of a fund reliant on just one company. "Many pensioners would not be happy with that idea," one Irish fund manager said. In addition most of the big Irish stocks are very cyclical for example paper (Smurfit) and building materials (CRH).

Nevertheless, during June the Davy index of Irish smaller companies rose by 3.57 per cent during the month compared to a 1.51 per cent fall in the Hoare Govett Smaller Companies Index in London. But one problem is that the Davy small cap is dominated by two "large" stocks, Irish Permanent and Woodchester which account for over 25 per cent of the index.

The gains among smaller firms contrasted with the larger indices which both fell in Britain and Ireland. "Irish institutions are missing a great opportunity by not investing," Mr Williams says. "The Irish smaller companies market provides attractive valuations as well as being a seriously under-researched market."

Mr John Lawrie, Irish fund manager at Scottish Provident, also believes Irish smaller companies provide excellent value. "I've been singing their praises for some time now," he says. "Although they have had a good run there's further to go."

But Mr Des Doran, Irish fund manager at Standard Life, points out that there is a higher risk premium attached to Irish smaller companies. "Disasters like Cambridge and Xtra-vision focused the market's attention on the potential risks," he says.

Although, Mr Doran adds, some smaller companies do offer good value. "We also hold nearly 10 per cent of the NatWest fund," he points out. "And some companies are undoubtedly good value."

Irish fund managers point out that when the new Developing Companies Market gets off the ground they will be investing more in Ireland. But some commentators question the likely size of the impact.

"What we need is a see-change in attitudes by Irish institutions to smaller companies overall," says Mr Williams. "If the smaller companies continue to outperform the ISEQ they will have to sit up and take notice."

Among individual companies, Mr Williams points out that Anglo Irish is an excellent high yielding stock with a gross yield of around 7.8 per cent in 1996 and 8.5 per cent in 1997. Among resource stocks Mr Williams picks out Navan, Petroceltic and Tullow Oil as being particularly attractive.