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Jupiter UK Smaller Companies fund manager on AO World, Ocado and more
Thursday 19 Jan 2017 Author: James Crux

With 2017 shaping up as another uncertain year, a fund with a bias towards high quality growth companies whose management teams have plenty of ‘skin in the game’ has appeal.

Step forward Jupiter UK Smaller Companies (GB00B3LRRF45), a unit trust with a strong record of outperforming the IA UK Smaller Companies sector.

Manager James Zimmerman is a stock picker inspired by feted investors Warren Buffett and Charlie Munger. He seeks to deliver long-term capital growth by investing mainly in UK smaller companies, although the fund also has modest exposure to international equities too.

Aiming to invest in high quality companies with significant growth potential, Zimmerman has whittled the portfolio down from circa 130 stocks to just over 50 names since taking over the fund in summer 2015.

Funds circle

How the manager picks stocks

Zimmerman says he looks for companies ‘where management have big stakes’. That process helps him whittle down the investable universe from the 1,300 companies in the Numis Smaller Companies AIM Ex Investment Companies benchmark to around 200 names.

He cites a study of the US market – ‘CEO Ownership, Stock Market Performance, and Managerial Discretion’ – which showed that between 1988 and 2010, businesses where management owned 5% or more outperformed the market over time by 4% annually.

‘If I fish in this pool of owner-managed businesses,’ says Zimmerman, ‘they will also outperform over time and by a wide margin.’

The manager also adheres to Buffett’s famed ‘circle of competence’. He routinely asks himself ‘is this a business that someone without technical knowledge in the industry can get their heads around?’ That approach tends to rule out oil and gas, healthcare and real estate stocks.

‘I’m looking for strong companies that can deliver double-digit annualised returns for shareholders from their current valuations,’ says Zimmerman. ‘And I go for really strong balance sheet businesses,’ continues the manager, whose portfolio holdings ‘tend to run with very strong balance sheets anyway because the guys have so much at stake.’

The manager readily confesses he doesn’t pore over analysts’ price targets. ‘Within the pond that I fish in, and with the criteria I have, I believe share prices will take care of themselves,’ explains Zimmerman.

Funds

Free marketing benefits

A fan of The Loyalty Effect: The Hidden Force Behind Growth, the 1996 book by Fred Reichheld of consulting firm Bain & Co, Zimmerman prefers companies that benefit from word of mouth as customers tell their friends about good service.

Relevant stocks in the fund include online retailers Ocado (OCDO) and AO World (AO.), as well as Majestic Wine (WINE:AIM) and Metro Bank (MTRO).

Zimmerman believes Ocado and AO World are trading at a discount to intrinsic value. ‘Both are being penalised for their lack of accounting profits and cash flow today, but they are proving their customer proposition is getting better and better and both operate with strong balance sheets in large markets,’ says the Jupiter man.

AO World is getting to a position where it is producing profit out of its UK business, but ‘people choose not to value the potential of Europe’, says Zimmerman. The manager stresses ‘the cash flow contribution from Ocado’s first two customer fulfilment centres is very strong at £80m or so.’

Funds table

Taking some profit in Fevertree

The fund also holds premium tonic water-to-ginger beer supplier Fevertree Drinks (FEVR:AIM). Zimmerman banked some profit on the stock in 2016 yet remains bullish on its potential.

‘I’m not expecting the bombastic, explosive (share price) performance from last year,’ he explains, although he sees scope for strong shareholder returns out to 2020 at least.

‘I think they have an exceptional management team, low penetration rates outside of the UK and they are growing the UK business at a phenomenal rate and haven’t fulfilled their potential in bars and restaurants and supermarkets.’

The fund can invest some money outside the UK markets. That explains why the portfolio has such holdings as US pet insurance play Trupanion (TRUP:NDQ). Zimmerman says chief executive Darryl Rawlings’ interests are strongly aligned with those of other shareholders.

New names to the portfolio

Last year, Zimmerman invested in Indonesian palm oil producer MP Evans (MPE:AIM). Six months later its share price surged after a bid from Kuala Lumpur Kepong (KPK) which was ultimately rejected by shareholders. MP Evans’ board argued the bid substantially undervalued the business.

Other fairly recent additions to the Jupiter fund include sector peer Anglo-Eastern Plantations (AEP), which owns and operates palm oil and rubber plantations in Indonesia and Malaysia.

It has also taken a position in Stockholm-listed financial services stock Avanza (AVANZ:ST). ‘It’s a Swedish equivalent of Hargreaves Lansdown,’ explains Zimmerman.

‘Avanza generates lots of cash and requires very little incremental growth capital. It is an internet-only business that has grown very rapidly over the past 10 years on the strength of the customer proposition. In five or 10 years’ time, it will be a much bigger business.’

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