Rob Gleeson and his FE Research team often have a preference for funds with a high proportion of assets in their best ideas, as it prevents any dead wood diluting performance.
While investing in a smaller number of holdings increases the stock specific risk, the team says that genuine star managers tend to perform better over the longer-term.
Warren Buffett is one of the best documented cases of an investor who has thrived on investing in a small basket of companies, referring to diversification as “di-worsification”.
Here are two examples of best ideas portfolio beating their better-known counterparts.
Old Mutual UK Smaller Companies Focus
FE Alpha Manager Daniel Nickols’ Old Mutual UK Smaller Companies fund is one of the largest and most popular in the IMA UK Smaller Companies sector, with assets under management (AUM) of £967m.
This is for good reason: FE data shows that the fund is a top-quartile performer in its sector over a 10 year period with returns of 339.54 per cent, and well ahead of its Numis Smaller Companies (ex IT) benchmark as well.
However, in spite of its strong record, Nickols’ much smaller Old Mutual UK Smaller Companies Focus fund has a superior record over the short-, medium and long-term.
The £130m portfolio is number one in the entire sector over the last decade by more than 55 percentage points, and ahead of both its peers and its benchmark over a one, three and five year period as well.
Source: FE Analytics
The fund’s top-10 represents much more of its total AUM than its larger counterpart – 24 per cent compared to 19.5 per cent. Old Mutual UK Smaller Companies has more than 120 holdings, while Focus has around 80.
FE data shows that Focus has been consistently more volatile than Old Mutual UK Smaller Companies, though the margin of outperformance has more than compensated for this.
When looking at the sharpe ratio – a standard measure for risk-adjusted return – the more focused fund comes out on top over one, three, five and 10 years.
The FE Research team rates Nickols as one of the best small cap managers around, and as a result, prefers to hold his higher-conviction portfolio.
“The manager has an unusual approach to investing in UK smaller companies compared with his sector peers: he not only performs bottom-up, fundamental analysis of each company to explain its stock performance, but also takes into account the effect the macroeconomic environment will have on each one,” he said.
“Nickols has a lot of experience in the UK smaller companies market and the fund is made up of his best ideas. Therefore this fund suits anyone who is happy for the manager to take on slightly more risk than he does in Old Mutual Smaller Companies.”
As well as performed better, the Focus fund is slightly cheaper, with clean share class ongoing charges of 0.93 compared to 1.05 per cent.
Invesco Perpetual UK Aggressive
While Invesco’s income desk tends to get all the plaudits, FE Alpha Manager Martin Walker has built a strong reputation in the UK All Companies sector.
He runs two funds – Invesco UK Aggressive and Invesco UK Growth – which have a very similar relationship to the two Old Mutual funds detailed above. Walker (pictured) draws on the expertise from the entire UK equities team, and combines that with his own screening process to pick growth prospects that he thinks are underestimated by the wider market.
The Aggressive fund is his best ideas portfolio, typically only comprising of between 40 and 50 holdings. Around half of the fund’s £286m worth of assets is in the top-10, including more than 17 per cent in Shell, BT and Rio Tinto alone. UK Growth has 41.8 per cent in its top-10.
UK Growth is the larger portfolio at £1.2bn, though Aggressive has been a much stronger performer over one, three, five and 10 year periods. Walker only took over from Stephen Anness in December 2012, though FE Research notes that the process has stayed exactly the same, and that performance has been very strong under the new manager.
FE data shows that the Aggressive fund has accelerated past Growth since Walker’s appointment, achieving top-decile returns of 55.34 per cent.
Performance of funds and sector since Dec 2012
Source: FE Analytics
FE Research points out the fund has recently upped its exposure to recovery-orientated sectors such as financials, and oil and gas, meaning it’s suited for more optimistic investors.
“Walker is expected to stick with these investments for the long-term, despite the potential for short periods of underperformance,” the team added.
The FE Research team more generally prefer high conviction managers, though notable exceptions include Giles Hargreave. His Marlborough UK Micro Cap Growth and Marlborough Special Situations funds have no more than 2 per cent in any one position.
Among the concentrated portfolios they currently rate highly include FP Argonaut European Alpha, Henderson European Selected Opportunities and Schroder Asian Alpha Plus.