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We find out how the top-performing managers in the smaller companies space make investment decisions
Thursday 09 Dec 2021 Author: James Crux

Among the best kept investment secrets is the fact smaller companies typically outperform larger companies over the medium and long term thanks to characteristics ranging from innovation and faster organic growth to entrepreneurial management, agility in the face of change and the greater likelihood of a takeover bid.

Within the UK’s small cap funds and investment trusts sectors is an elite cohort of collectives that have consistently outperformed over economic and stock market cycles, each pursuing a winning process that should pique the interest of investors.

Using data from FE Fundinfo, Shares has uncovered the best-performing UK small cap funds and trusts of the past 10 years, a sufficiently long timeframe to include stock market ups and downs and therefore a good indicator of a fund’s consistency.

In this article we reveal some of the secrets of their success, highlight key points of differentiation and the philosophies and processes that are enabling these portfolios to make money for investors.


Our table of top 10-year total return performers is headed up by a trio of investment trusts; Oryx International Growth Fund (OIG) has generated more than 740% return, the Dan Whitestone-steered BlackRock Throgmorton (THRG) is up by the best part of 600%, while Henderson Smaller Companies (HSL) has delivered a total return north of 500%.

Steered by Christopher Mills and his team at Harwood Capital Management, Oryx International Growth’s success stems from an unwavering focus on firms with good prospects, active management and conservative balance sheets, a winning formula that continues to serve shareholders exceptionally well.

The year to March 2021 proved another fruitful one for Oryx, with net asset value increasing 86% to £16.42 per share and the share price increasing 122% to £14.90. Despite this stellar long-run record, Oryx shares trade on an 8.7% discount to NAV.


Trading at a 9.5% NAV discount is Henderson Smaller Companies, which has a formidable long-term performance record since Neil Hermon was appointed lead fund manager in 2002.

In the year to May 2021, the trust outperformed its Numis Smaller Companies Index ex-Investment Companies benchmark by 4.4%, marking the 16th year of outperformance in the 18 years Hermon has been managing the portfolio, and investors were also treated to the 18th consecutive year of dividend increase.

Aiming to maximise shareholders’ total return by investing in UK-quoted smaller companies, the consistency of this outperformance reflects the quality of the investment style and approach of Hermon and his team, which also encompasses Indriatti van Hien and Shivam Sedani, a trio that looks for quality growth at the right price.

Hermon says: ‘The (consistent long-term) performance has principally come from stock picking. Frankly, it’s the ability for us to find and select companies that will deliver great long-term returns for investors.’

He stresses that the consistency of the approach is key. He is on a quest to buy quality companies with above-average growth potential and defines the quality criteria by what he dubs the ‘4Ms’. He looks at a company’s business model; its economic franchise, competitive advantage and pricing power.

Secondly, he assesses the management team. Next is money, by which he means the strength of the balance sheet and cash flow.

Last is earnings momentum – the ability to beat market expectations and maintain earnings growth into the future. Pressed for prime examples of classic ‘4Ms’ in the portfolio today, Hermon highlights ESG-focused fund manager Impax Asset Management (IPX:AIM) and high-flying media group Future (FUTR).

‘We look for those “4Ms” in the portfolio companies and it is a process that hasn’t changed over that 18 year period,’ explains Hermon. ‘It works very well. The average holding period of a stock in the portfolio is over five years, so we’re very much long-term investors. That’s been a key driver. Some of our best returns have come from those conviction positions that have been held for a long period of time.’

Capital growth, rather than income, has driven these returns, though Hermon likes his companies to pay a dividend and the avoidance of ‘blue sky’ or loss-making businesses had helped along the way.

It is also worth noting that Henderson Smaller Companies actually has a mid cap bias; this reflects the fact Hermon is keen to ‘run the winners’ as they move up through the market cap ranks, as well as liquidity and benchmark weighting reasons.

‘We’re not small companies, we’re smaller companies,’ adds Hermon. ‘And we’re not a one trick pony – we can do well in both up and down markets. We have a GARP (growth at a reasonable price) process and philosophy, but we also have a bit of a value bedrock.’


BlackRock Throgmorton’s success reflects what manager Dan Whitestone argues is the company’s ‘unique toolkit relative to other trusts in the peer group, and proven investment process which focuses on stock specific alpha generation rather than taking top down macro views’.

Over the past five years, Throgmorton has seen extremes of volatility, with a constant flow of macroeconomic headwinds, most recently the pandemic. Yet as Whitestone explains: ‘Given the focus of our investment process is bottom-up, we take little to no notice of these factors, but they serve as an important reminder to us that stock and industry specifics triumph over short-term macro noise that often occupy the news headlines.’

This £947 million cap trust, trading on a 1.8% premium at the time of writing, aims to achieve long-term capital growth by investing in small and mid-cap growth companies which Whitestone thinks have potential to grow their earnings at elevated rates for many years and so have the potential to become much bigger companies.

‘These companies have strong management teams, with a protected market position, a unique and compelling product offering, and are well financed. And they are unlikely to be affected by the short-term vagaries of the market or political environment,’ he says.

Companies in the portfolio range from industrial and electronic equipment supplier Electrocomponents (ECM) and luxury watch retailer Watches of Switzerland (WOSG) to communications tech developer Gamma (GAMA:AIM) and cutting-edge science tools designer Oxford Instruments (OXIG).

Whitestone invests in companies that are leading industry change. He says we are living in a world where advancements in technology are ‘accelerating many long-term secular trends and this is fundamentally changing the behaviours of both consumers and corporates influencing how, what and where they purchase goods and services.’

The BlackRock money manager also points out ‘we are witnessing accelerated market share shifts intra-industry either through product-led investment, or enhanced network and scale capabilities, or manufacturing models with lower cost unit economics which means that the pricing architecture of legacy incumbents can be undermined.’

This can be great for the winners but can ‘create catastrophic problems for the losers that aren’t able to adapt to the fast-changing landscape of the industry in which they
operate in’.

A significant point of difference for BlackRock Throgmorton is it takes short positions, where it would profit from a falling share price.

‘This means that the trust can not only capitalise on owning differentiated growth companies that see their share prices multiply over time, but also from shorts in companies that operate in challenged industries, with weak financial structures, that fall victim to industry change,’ says Whitestone.


JPMorgan UK Smaller Companies Trust (JMIis another uber-consistent trust. Being disciplined is extremely important to co-managers Katen Patel and Georgina Brittain.

‘Staying true to our process and focusing on the fundamentals of the companies within our investment universe in the face of perceived market sentiment changes or periods of heightened market volatility, has stood us in good stead over the long-term,’ says Patel, also flagging the use of earnings momentum as a key part of the investment process.

‘Spending our research time on businesses that have delivered better than expected operational performance has been really helpful. This allows us to focus on exciting early stage names and also businesses that are starting to show signs of a successful turnaround,’ he explains.

Patel points out that the numbers are the most important variables looked at when deciding whether to buy or sell a stock. Companies are sold ‘when that stock becomes too large for our remit and/or when the company’s earnings momentum is decelerating. In such instances, we would rather sell the stock and reinvest it in something that will gives us better returns over the longer term,’ says Patel.

‘Exits require a quick decision and we try to remove emotions from these investment decisions. We keep our focus on the numbers, which makes it easy for us to be swift in our response.’

Patel continues to see attractive opportunities within the UK smaller companies space, noting their continued long-term outperformance
over large caps.

‘One company that we believe presents attractive growth opportunities is Halfords (HFD), which has very compelling ESG credentials; the company is focused on independent transportation – including bikes and e-scooters – and its commitment to championing all types of electric transportation, and to helping its customers make the transition from petrol and diesel cars to electric vehicles, is what makes us excited about its future.’


Within the open-ended funds universe, Liontrust UK Smaller Companies (B8HWPP4) can be rightly proud of generating a 10-year total return of 485%. Managed by Anthony Cross, Julian Fosh, Victoria Stevens and Matt Tonge, this formidable record is a result of the fund’s tried-and-tested ‘economic advantage’ process, which seeks to identify companies with a durable competitive advantage that allows them to defy industry competition and sustain a higher than average level of profitability for longer than expected.

Additional ingredients that make up its secret sauce, according to co-manager Stevens, include looking for managers with ‘skin in the game’. When applying the Liontrust economic advantage process to smaller companies, one of the key extra requirements the portfolio managers look for is a minimum 3% management equity ownership level.

‘An “owner-manager” culture not only aligns the interests of company management with ours as shareholders, but also encourages them to manage the business more conservatively,’ argues Stevens.

She also explains that economic advantage in smaller companies is ‘created and maintained by talented individuals. Research demonstrates equity ownership motivates key employees, helps to secure a company’s competitive edge and leads to better corporate performance.’

Managing the risk of investment bubbles or fads is a further facet behind Liontrust UK Smaller Companies’ long-run success. You won’t find these fund managers investing in ‘jam-tomorrow’ stocks on lofty valuations with ‘little to underpin them other than a good story’, says Stevens.

‘Having a clearly-defined investment process helps combat emotional bias, enforcing evaluation of opportunities within a distinct framework,’ she continues. ‘We also manage this risk by avoiding loss-making companies, instead focusing on stocks which generate profits and cash flow to underpin their market valuation.’

Furthermore, all holdings are graded on risk factors ranging from financial and ESG risk to product dependency, customer dependency, pricing power, valuation and acquisition risk, and the resulting overall risk score determines that stock’s portfolio weight. ‘We invest a smaller proportion of the fund in riskier companies,’ says Stevens, ‘with a maximum weight of 4% in any single holding. This leads to lower overall portfolio volatility, while still allowing exposure to high-growth smaller companies.’

Holdings include patent translations-to-intellectual property support services provider RWS (RWS:AIM), where long-run driving force and executive chairman Andrew Brode still owns 23% of the equity.

According to Stevens, RWS is ‘rich in the intangible assets which our economic advantage process seeks out due to their ability to confer a sustained competitive advantage’.

RWS boasts strong intellectual property through the know-how of its skilled translators, who often combine both a language and a scientific academic discipline, and its intellectual property advantage was ‘further strengthened through the acquisition of SDL, with its proprietary technology.

‘The company’s scale and coverage of overseas offices has also created a powerful distribution network, allowing RWS to service the needs of large global enterprise clients across all jurisdictions.’

One holding in the Liontrust fund is Eckoh (ECK:AIM), a provider of software solutions used in customer contact centres which has also developed a patented payment solution which enables customer payment information to be received in a secure way.

Stevens says Eckoh is an example of a stock which possesses all three of the core intangible assets the economic advantage process seeks: it has patented intellectual property, a sticky customer base affording it an embedded distribution network and enjoys recurring revenues of over 70% of turnover.


Over the last 10 years, TB Amati UK Smaller Companies (B2NG4R3) has returned almost 360%, success which Amati Global Investors’ fund manager Anna Macdonald pins on the fact that ‘we run all our smaller companies products (the TB Amati UK Smaller Companies Fund, Amati AIM VCT and IHT portfolio service) as a team, pooling our knowledge and expertise.’

She says the smaller company fund gives investors ‘exposure to small and medium sized companies that we believe can deploy capital at high rates of return. This requires management teams who have deep knowledge of their market segments and the personal skills and commitment necessary to develop a business successfully over the long term.’

In addition, she says: ‘We study different industries to understand how innovative approaches and technologies can create niches where smaller businesses will be able to find significant opportunities. Our ability to actively seek these opportunities, and hold them for the long term, drives our performance.’

Among the holdings is eyewear frames specialist Inspecs (SPEC:AIM), floated on AIM in 2019 by founder/CEO Robin Totterman.

‘He retains a significant stake in the business, something we consider a big tick in the box, as it confirms shareholders and managers are aligned,’ explains Macdonald.

Making own brand and licensed frames for spectacles and sunglasses, Inspecs has grown organically and via acquisition to become a top five player in the market. 

It has diversified frame production away from China, a country where 90% of the world’s frames are made. Macdonald says the
company also acquired ‘excellent distribution throughout Europe when buying Essenbach, a German competitor, in a significantly earnings accretive acquisition’.

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