The fund’s net long position – its long positions minus its shorts – has been steadily rising since the summer of 2012.
Cox says that he and the fund's other manager Richard Plackett are positioned in a number of cyclical sectors set up to prosper from an improving UK economy.
“The last two years have been strong for equities,” he said. “We are not expecting a re-rating but we are very confident and favour developed companies over the developing world.”
Cox and Plackett’s £39.8m investment trust takes long and short positions in smaller companies and has an excellent track record of grinding out returns, even in down markets.
The fund feeds in to the £600m BlackRock Hedge Fund with the same strategy. The closed-ended fund was launched in 2009.
According to the managers’ own figures, it has made money in 61 per cent of negative markets and 87 per cent of positive ones.
It made positive returns in 2008, even though it was net long. In that year the UK equity market lost 49.39 per cent.
Unfortunately, FE Trustnet doesn’t have data for the hedge fund for that year, but BlackRock says it was up 23.17 per cent while the average hedge fund lost 37.06 per cent.
Performance of index and sector in 2008
Source: FE Analytics
The managers are playing a number of bullish themes in their long book, including the UK housing market.
The fund holds housebuilder Bovis Homes along with Bellway and Berkeley Group. Estate agents Countrywide, Big Yellow and Foxtons are also in the portfolio.
Plackett and Cox also have positions in a number of companies benefiting from improving consumer confidence, many of which were top performers last year.
They have retained their position in FTSE 250 stock kitchen manufacturer Howden Joinery, which doubled in value in 2013.
Performance of stock vs index in 2013
Source: FE Analytics
Last year was one of multiple expansion for the business, but the fundamentals will come through in 2014, Cox says.
Workspace, Young's, Booker and Dunelm fall into the same basket. The fund has also built up significant holdings in small cap tech stocks with an edge, such as Xaar, Oxford Instuments, WANDisco and Plexus. Internet stocks Abcam, Blinkx, Optimal Payments and YouGov also feature.
Cox can’t speak about the stocks he is shorting for compliance reasons, but he does say that it is easier to find both long and short ideas now that the market has become more volatile.
A market dominated by fundamentals rather than multiples expansion suits his style, he explains.
“It’s easier to find shorts now than two years ago: we have been through a period of low volatility and we have seen volatility pick up markedly,” he said.
The manager adds that what he looks for is the opposite of what he seeks in a long position. First, he and Plackett look for weak management teams.
“This may be those that are inconsistent in what they tell us in meetings,” he said.
Secondly, low barriers to entry in the industry are a red flag – for this reason the food processing sector is unappealing, he says.
The third factor he looks for is cash conversion: companies with a track record of not generating cash are good shorts.
Fourthly, the managers look for a consistent track record of positive performance on their long book and inconsistent performance in their shorts, meaning that they avoid the “turnaround” companies which receive a lot of attention from retail investors in the smaller companies sector.
Finally, the managers look for weak balance sheets, looking at an inclusive definition of debt that includes property leases and pension obligations.
“Financial and operational leverage together can be great or they can be awful,” he said.
Cox says he has learned from experience that shorting can be more damaging when it turns against you than long positions can; therefore the fund’s short positions are smaller than its longs, with an average size of 0.5 to 0.6 per cent.
The managers have 80 long positions, with a maximum value of 3 per cent each, and 90 short positions with a maximum value of 1 per cent.
Another bullish theme the managers are playing is the shift from bonds into equities. Last year there was much talk of a potential “great rotation” from bonds into shares, but this didn’t materialise to the extent expected.
Cox says that the process is underway, however, and as a result he and Plackett hold a number of specialist equity fund houses. These include Polar Capital, which they say has “excellent teams” and a strong track record of outperformance, as well as Brewin Dolphin, Rathbones and Jupiter.
“The switch from bonds into equities is happening: as a fund manager [at BlackRock] we can see it in our funds,” he said.
The manager says that the growing volatility and dispersion of returns in the market is playing right into the hands of a fund like his, while the smaller companies bias will also help it.
“The advantage of very small companies is they are able to take market share in tougher times,” he said.
However, the fund is not for those that seek bullish smaller companies exposure. Over the past three years it has returned just 10.81 per cent to the Numis index’s 58.89 per cent.
Performance of trust vs index over 3yrs
Source: FE Analytics
Rather, it is its ability to grind out returns in up and down markets that is the selling point, as well as its extremely low volatility: just 4.15 per cent over three years compared with 14.7 per cent for the Numis index.
The fund has ongoing charges of 0.54 per cent plus a performance fee. It is on a 0.6 per cent premium.
