Valuations for the small-cap asset class have returned to levels last seen during the Global Financial Crisis, and history shows that when valuations have plunged to similarly low levels in the past, stellar returns have ensued for small caps over the subsequent five years.

A savvy way to gain differentiated exposure to this structurally-inefficient part of the market is through value-focused investment trust Rockwood Strategic (RKW), which has generated five-year annualised total returns of 18.5% and is ranked the number one fund over one, three and five years by NAV (net asset value) total return in the Association of Investment Companies (AIC) UK Small Companies sector.

HOW IS ROCKWOOD DIFFERENT?

Managed by Harwood Capital’s Richard Staveley, who is 100%-focused on Rockwood and has personal ‘skin in the game’, this is a highly-concentrated portfolio of stocks with ‘deeply undervalued future cashflow potential’ and rerating catalysts in place which is benefiting from net asset value-boosting takeover approaches left, right and centre.

Staveley’s tried-and-tested strategy identifies undervalued stocks where the company will benefit from operational, strategic or management changes that can unlock or create value for investors. Rockwood’s differentiated approach of taking active stakes in core holdings is proving highly effective, and by total shareholder return the £50.8 million trust is ranked number one in the sector over three and five years.

‘We’re not benchmark aware or focused, which almost every small cap fund is,’ explains Staveley, ‘and we are targeting 15% absolute returns over three to five year rolling periods.’ Rockwood invests in stocks which can deliver 15% IRRs (internal rates of return) over five years and currently has eight ‘core’ holdings and 13 ‘springboard/opportunities’.

Another point of differentiation with its peers is the majority of stocks in the portfolio are recovery situations rather than growth plays. ‘Value will out, and value is coming back in a major way,’ insists Staveley, stressing that despite the downbeat commentary, small-caps are on the radar of trade buyers and private equity.

To illustrate, Rockwood has recently received bids for Finsbury Food (FIF), taken over by private equity, as well as Smoove (SMV:AIM), OnTheMarket (OTMP:AIM) and City Pub (CPC:AIM).

‘When you get a bid in a concentrated portfolio, it really makes a difference to the overall performance metric,’ he enthuses. ‘We run our winners and allow them to grow into quite big parts of the fund. Crestchic, previously our largest holding, which got taken over in Q1 of this year, actually got up to about 23% before the bid came in.

‘Most small cap managers would start freaking out if one of their holdings got up to even 5%. But we think that concentration allows us to de-risk the approach by being able to spend a lot more time on each holding than an average fund manager would.’

PACKED WITH POTENTIAL

As of 30 September 2023, Rockwood had 21 holdings of which the top 10 constituted 64.2% of NAV, among them exciting recovery stocks with new management such as RM (RM.), the indebted educational supplies leader with potential for divisional disposals, and the fasteners maker and distributor Trifast (TRI).

Other top holdings include construction group Galliford Try (GFRD), marketing services business M&C Saatchi (SAA:AIM) and specialist components-to-services firm Flowtech Fluidpower (FLO:AIM).

Staveley is excited by a wealth of high-quality managerial and board changes at Rockwood investees of late, where self-help actions are set to drive shareholder value ‘irrespective of the doom and gloom’.

New investments include James Fisher & Sons (FSJ), the specialist engineering services provider to the energy, defence, renewables and marine markets, which Staveley views as a classic ‘fallen angel’, and records management-to-life-cycle services concern Restore (RST:AIM), which he says has been ‘exceptionally lucky’ to have lured back former chief executive Charles Skinner.

As he commented in Rockwood’s first-half results (22 November), ‘the redeployment of takeover receipts fills us with great excitement given our pipeline of new opportunities and these “buyer’s” market conditions. When the market environment eventually changes we expect the re-rating of  our holdings to be material as investors belatedly react to the catalysts that are now in place across the portfolio for improved profitability and value creation.’

Admittedly, a small NAV premium means investors are giving up some performance, and ongoing charges are on the high side, yet Shares believes it is worth paying up to access Staveley’s stockpicking acumen and the portfolio’s potential. for value uplift

Smart investors agree, as Rockwood has been issuing shares at a small premium to NAV to satisfy demand for Staveley’s winning strategy.

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