Coombs, who runs a number of portfolios including the Rathbone Multi Asset Total Return fund, says that alarm bells should start ringing at this level, as the ability to add value through small and mid-caps is increasingly difficult.
“Any multi-cap fund that has £2bn in it makes us think again,” he said. “Even at £1.5bn we take a look because it can then grow to £2bn very quickly.”
“This is a particular problem in the UK sectors, and one of the reasons why we have less in this area – a lot of money is going into the best managers and it’s making our life difficult.”
“The difficulty is that funds grow from £500m to £5bn very quickly. If the manager is investing predominantly in large liquid stocks this isn’t an issue, but it is when you’re looking at multi-cap funds.”
Coombs defines a multi-cap fund as one that has close to 50 per cent of its assets in small and mid-caps.
He points to one of his favourite holdings – AXA Framlington UK Select Opps, managed by FE Alpha Manager Nigel Thomas (pictured) – as an example of one that he is growing wary of.
The £4.8bn fund boasts an impressive record even in recent years, but Coombs thinks that Thomas has less chance of adding value now than he did in the past.
“We still hold Nigel but I am concerned. We’re not currently adding money to it,” he said.
Performance of funds and index over 5yrs
Source: FE Analytics
“If I look at some of our other UK holdings like [Slater Growth and GVO UK Focus] they are now the high risk stockpickers, while Nigel is now more of a quasi-core holding.”
AXA Framlington UK Select Opps currently has 60 per cent in large caps and 3.7 per cent in cash, with the rest split between micro, small and mid-caps.
It must be said that Thomas’ top-10 is very different to the average UK growth fund. He has big off-benchmark positions in the likes of Travis Perkins, Shire, Essentra and Wolseley.
Coombs notes that Thomas has a very low turnover which lessens the problem of liquidity, and says this is the reason why he continues to hold on to the fund.
Speaking on behalf of the group, Rob Bailey, head of UK wholesale distribution denied claims that Thomas could lose its edge: “The fund managed has an unconstrained multi-cap approach. Nigel invests in stocks where he believes an opportunity exists, be that in small, mid or large cap companies as he strives to create a well-diversified portfolio for investors.”
“We do not have concerns over ‘capacity constraints’. We closely monitor and review the size of the fund at prescribed intervals in order to ensure that Nigel can constantly apply his investment approach as the fund grows.”
“With its low turnover it is well suited to long-term investors and the fund has continued to outperform even though it has been growing consistently over the 10-plus years that Nigel has been running it.” Coombs says he has some doubts over FE Alpha Manager Francis Brooke’s Trojan Income fund as well, which he holds across his range. Strong risk-adjusted returns in recent years, particularly during falling markets, have seen assets in the fund grow to £1.6bn.
Brooke (pictured) says he doesn’t believe his fund falls into the multi-cap category, and has no concerns over fund size.
“If you include my overseas holdings I have around 75 per cent in the FTSE 100,” he said.
Performance of fund, sector and index over 7yrs
Source: FE Analytics
“‘Our style means we rarely invest in small caps as they don’t tend to have the characteristics I look for – namely quality franchises with good cash flow and predictably earnings.”
Trojan Income is closed to new money if you’re investing direct, but it remains available on most major platforms.
Using the 2bn cut-off point, other UK multi-cap funds that are at risk of getting too big in Coombs’ eyes include Fidelity Special Situations, JOHCM UK Equity Income, Schroder UK Opportunities and BlackRock UK Special Situations. All have a sizeable chunk of their assets outside the FTSE 100.
The Rathbone multi-asset team points to Tom Dobell (pictured), manager of the M&G Recovery fund, as a fund that they have sold out of because it has gotten too big in recent years.
“There’s the idea that inflows are a good thing because it means the manager is popular and therefore must be good, but again we would have to disagree,” said Mona Shah, assistant portfolio manager on the Rathbone multi-asset team. “If you look at M&G Recovery, when it hit the £4bn mark performance started to deteriorate. We don’t think that he’s gotten worse as a manager, but the environment has changed and led to performance going off the boil.”
“If he launched an investment trust tomorrow we may well invest, but we think the size is an issue.”
Coombs added: “We are not suggesting in any way that Tom Dobell is not a good investment manager, but we are saying that when looking at where he has generated alpha in the past, it was very much in small and mid-caps.”
He says that fund size is less of an issue for managers who invest predominantly in large caps, such as FE Alpha Managers Neil Woodford and Adrian Frost.
“If you look at someone like Woodford, [his ability to add value has come] more from sector bets,” said Coombs.
FE data shows that the performance of the M&G Recovery fund has deteriorated in recent years. The now £6.8bn fund was a top-decile performer in the 10 years following the manager’s appointment in March 2000, with returns of almost 100 per cent. The All Share was up just 29.71 per cent over the period.
However, since March 2010 the fund is a bottom quartile performer in its IMA UK All Companies sector and well behind the FTSE All Share index, with returns of 30.67 per cent.
Performance of fund, sector and index since 31 March 2010
Source: FE Analytics
Dobell has repeatedly denied claims that fund size has been the driver of underperformance, insisting he has more than enough flexibility to add value through small and mid-cap companies.
He says that the last three years or so hasn’t rewarded his deep value style, with stock specific issues – particularly in mining and industrials – contributing to the underperformance.
A number of industry experts have retained faith in M&G Recovery, however. Hawkmoor’s fund of funds manager Daniel Lockyer recently highlighted the fund as one of the few multi-billion portfolios he is willing to buy.
Coombs says another fund he has sold out of in recent years due to concerns over capacity is Paul Marriage’s £1.1bn Schroder UK Dynamic Smaller Companies portfolio. It has since closed to new money.
Shah says that Rathbone has a tendency to look at smaller funds, which are often part of lesser-known boutique firms.
“We have the resources and the willingness to do our due diligence and look at alternatives,” she said.
“There’s a bias towards big firms. Many think that this makes investments somehow safer, but this is not always the case. The more flexible a fund is, the more likely it is that it is going to be able to hit its objectives.”
Among Coombs and Shah’s favoured boutique funds at the moment include Edgewood US Select Growth, Heptagon Oppenheimer Developed Markets Equity and recent addition Michinori Japan Equity.
The team also likes investment trusts, as these aren’t subject to sudden inflows and outflows. The Henderson European Focus Trust and JP Morgan Japanese IT are both top-10 holdings in Rathbone Multi Asset Enhanced Growth.
Mike Webb, chief executive of Rathbones Unit Trust Management, says that fund groups need to be more active in closing funds to new money, but acknowledges the difficulties in doing so.
“It is a very hard decision as a chief executive – trust me – but it’s also a very hard thing to achieve,” he said. “Do you put a big initial charge on? Do you up the minimum investment?”
“It’s also not that easy to close it on all the platforms. It would good if there was an easy way to [stem flows], but there isn’t at the moment.”
Coombs added: “The problem we have is that managers can lose control of their portfolios because distribution teams take over. It is important that this doesn’t happen.”