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Collectives with a lower level of assets can be more agile and flexible than their larger counterparts
Thursday 03 Jun 2021 Author: Ian Conway

Sometimes investors ignore funds which have accumulated a limited amount of funds from investors, often because they are seen as not having much of a future due to a lack of scale or just because they don’t have the marketing budgets of the big asset managers.

However, ignoring these smaller funds could mean neglecting some potentially interesting investment options.


While we are long-term admirers of fund management ‘legends’ who have built multi billion-pound businesses, like Terry Smith and Nick Train, one of the disadvantages of running enormous amounts of money is the inability to invest in smaller companies.

Quite simply, if you run a fund managing £1 billion or more, investing anything less than 1% or 2% (ie £10 million or £20 million), in an individual stock isn’t going to ‘move the needle’ in performance terms unless that stock is going to double.

That inevitably limits the size of company you as a manager can invest in, as most funds have rules on the size of holdings meaning typically they can’t own more than say 5% of a company’s outstanding equity.

Anyone looking to invest £10 million to £20 million in a single stock is therefore likely to be prohibited from investing in companies with a market cap below say £400 million.

Hence Smith set up Smithson (SSON) to invest in ‘small- and mid-cap investments that have superior operating numbers’.

Meanwhile, liquidity rules typically mean large funds can’t buy anything which doesn’t turn over the value of its holding several times a day in the secondary market. In practice, that could mean it is limited to owning stocks with a market cap of several billion pounds.


Not only do funds with lower assets under management have more flexibility in what they can invest in, smaller companies have historically outperformed larger companies because they grow their earnings faster, so a higher exposure to small cap stocks should generate outperformance.

Also, smaller listed businesses tend to be less well-researched than large caps, so in theory there should be more ‘undiscovered’ opportunities. On the flipside small caps can be harder to deal in and prices can be more volatile.

Just as with larger funds, there are different strategies among smaller funds, ranging from quality growth to value and momentum. Sometimes managers who have established track records elsewhere can be found managing less established funds. Below we look at five examples of funds with relatively limited assets.


TM Crux UK Special Situations Fund (BG5Q5X2)

Market cap: £96 million

Manager: Richard Penny

As its name suggests, the fund sets out to find stocks which due to ‘special’ circumstances the manager believes are mispriced.

This could mean a company’s shares are down in the dumps because investors have been disappointed and lost confidence after the latest trading update, but the manager sees upside potential beyond the short term.

On the other hand it could be that the market has failed to accurately price in a company’s high underlying growth potential.

Aside from a low price, Penny looks for good management teams, usually with their own money invested in the business; low levels of debt; broad geographic exposure; and the potential to generate sustainably high returns on capital.

‘The UK stock market seems to be going through a “textbook” recovery progression’ says Penny, a seasoned manager who had a long spell at Legal & General Investment Management. ‘After a strong period of performance some of the larger more obvious recovery stocks now have less upside, and the outperformance may well come from smaller and micro-cap companies.’

The fund has racked up a good performance in stocks like Rio Tinto (RIO) and Bellway (BWY) but recent outperformance has come through holdings in much smaller names like Diurnal (DIU:AIM), Ebiquity (EBQ:AIM) and Escape Hunt (ESC:AIM).


MFM UK Primary Opportunities Fund (B905T77)

Market cap: £27 million

Manager: Oliver Brown

The fund takes the unusual but straightforward investment approach of ‘only buying good quality companies when there is a natural, primary opportunity to do so’, such as an initial public offering or a placing.

‘This allows us to typically buy at a discount to the market price, adding alpha and protecting the downside,’ says the manager.

Thanks to a strong market for initial offerings and placings, the fund had a busy start to 2021. As well as adding new investments in Arena Events (ARE:AIM), Barclays (BARC), Chrysalis (CHRY) and Duke Royalty (DUKE:AIM), the firm participated in the flotations of MusicMagpie (MMAG) and PensionBee (PBEE).

The UK’s successful vaccination programme, together with a positive first quarter earnings season with many companies raising their outlook, meant markets performed well.

In April the fund rose for a sixth consecutive month, returning 5.4% against 4.3% for the FTSE All Share and 4.2% for the Investment Association’s UK All Companies sector benchmark.

Inevitably, the fund’s strategy means a higher than average level of turnover as stocks which have performed well are sold to fund new investments. Sales in April included Accrol (ACRL:AIM), GlaxoSmithKline (GSK), The Hut Group (THG) and Watches of Switzerland (WOSG).


CFP SDL Free Spirit Fund (BYYQC27)

Assets: £98 million

Managers: Andrew Vaughan, Keith Ashworth-Lord

The fund applies what it calls the methodology of Business Perspective Investing, picking stocks according to their ‘strong customer proposition, with pricing power and growth potential, with sustainability assessed by reference to identifiable economic moats’.

It is an approach co-manager Keith Ashworth-Lord has pursued with some success at the much larger fund – CFP SDL UK Buffettology (BF0LDZ3).

To be selected for the portfolio, stocks must have high returns on capital employed, sound balance sheets, strong conversion of earnings to free cash flow, and ‘rational allocation of capital by management’, a factor which can trip up many firms.

The fund outperformed the market and its peer group in the year to the end of February, racking up a 20% gain compared with a 5% rise in the FTSE All Share and an 8.5% rise in the IA’s UK All Companies Sector.

The fund had limited direct exposure to travel and hospitality or to the ‘troublesome’ oil and gas or banking sectors. ‘Our perennial preference for non-consumer facing businesses with locked-in recurring revenues and strong balance sheets came into its own, without having to reposition the portfolio’, says Vaughan.

However, growth investing ‘is about more than just protecting the downside’, he adds. Portfolio companies need to keep investing in their businesses to strengthen their competitive positions and drive future returns on capital.

‘These are the traits we focus on rather than distractions such as the level of the wider market or whether a so-called ‘value’ style might underperform or outperform relative to a ‘growth’ style in the near term.’


Heptagon European Equity Focus Fund (BPT3468)

Assets: £60 million

Manager: Christian Diebitsch

The fund employs a high-conviction, stock-specific investment strategy to identify a small number of companies with focused business models which demonstrate genuinely sustainable long-term growth prospects and can be bought below their intrinsic valuations.

The fund purposely avoids areas such as commodities, fossil fuels, gambling, tobacco and weapons, and is actively engaged in fostering good ESG practices among companies whose shares it owns. It has consistently scored highly on ESG criteria with ratings agencies such as Morningstar and MSCI.

In contrast to the other funds covered, the manager favours large-cap stocks with ample liquidity, and as well as UK holdings such as Diageo (DGE) and Serco (SRP), many of its European holdings will be familiar to UK investors, including German sportswear maker Adidas, Dutch chipmaker ASML, French cosmetics giant L’Oreal and Danish insulin-maker Novo Nordisk.

The advantage of this is that, as the fund grows in size it doesn’t need to change style or strategy as the stocks it owns are liquid enough to cope with much bigger position sizes, meaning it is scalable.

The majority of the fund’s holdings beat expectations in the first quarter, leading to upgrades and demonstrating what the manager calls the ‘sales and earnings power’ of the portfolio.

‘It goes to show that the investment community generally underestimates companies’ ability to adjust to changes in business conditions, as in the current case by converting their operations and business models to a digital format and by embracing e-commerce’ he adds.


MI Chelverton European Select Fund (BFNL2P3)

Assets: £44 million

Manager: Dale Robertson, Gareth Rudd

The fund invests in companies across Europe, excluding the UK, down to a market cap of €50 million, which it believes are undervalued by the market and which offer what it calls a ‘safety buffer’ should the market correct.

The managers argue that the traditional ‘value investing’ approach, which relies on mean reversion, is no longer applicable given the pace of technological change and the emergence of ‘disruptors’ in many businesses.

Instead of looking at earnings, they focus on analysing a company’s free cash flow, cash conversion, working capital and fixed capital intensity. In order to avoid ‘value traps’, they steer clear of companies with high levels of net debt and the portfolio as a whole tends to have a much healthier credit profile than the market.

The fund has a large weighting in technology and industrial stocks, but few investors are likely to recognize many of the holdings as they are typically small-cap and highly specialized.

In fact, aside from a handful of mega-cap stocks such as Total and Unilever, most of the holdings will be completely foreign to UK investors, such as lead holding Caverion, a Finnish building systems provider, and second-largest holding, Belgian industrial insulation manufacturer Recticel.

Disclaimer: The author (Ian Conway) owns shares in Heptagon European Equity Focus Fund.

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