Derek Larcombe, manager of the Quilter Global Growth and Global Income funds, says the small-cap rally still has further to run, and particularly favours UK smaller companies.Both the Quilter funds are funds of investment trusts. Larcombe (pictured) says that despite the strong performance of small-caps in 2003, he can still buy smaller company trusts at decent discounts to net asset value. He adds: “In some cases I am getting 100p worth of assets for 76p, because others still wish to sell. They are looking at fundamentals and believe the market is too high.” Larcombe takes a contrarian approach, aiming to buy trusts that have wide discounts because sentiment is against them. He says that investors should look back to the market recovery in 1998 and 1999, where small-caps rose by more than 100%. With small-caps up around 50% last year, he believes there is still further to run. Larcombe adds: “It’s all to do with the cycle. When small-caps get oversold, entrepreneurs come in and take them into private hands. That generates changes in sentiment. At the moment, this part of the cycle is still going on. Once the companies are in private hands, they are restructured and gradually they start to float again. Everyone starts clamouring for them – there are new issues and then the general public comes in. Sentiment is changing now. There is still more to run and I don’t know when it will stop.” An over-emphasis on fundamentals can be misleading, according to Larcombe. He points out that between 2000 and 2002 fundamentals were not bad, but the market collapsed, while in 2003 the fundamentals did not change, but the markets rose substantially. On this basis, he has only 4% of his fund in the Far East, despite the strong economic prospects for the region. With trusts now trading near net asset value or at a premium, he believes there is little value to be found here. The Quilter Global Income and Global Growth funds are first and second respectively in the S&P Equity Global sector over the year to December 29. Larcombe says it is the small-cap exposure that has generated most of this outperformance.