Shillito started buying the five crown-rated fund for his OEIC and ISA in February 2013, despite its short track record and poor returns, and was met with downright derision from some of our readers.
However, FE data shows that PFS Downing Management is the best performer in the IMA UK Smaller Companies sector this year, with returns of 12.3 per cent, while the average fund has lost money.
Performance of fund vs sector in 2014
Source: FE Analytics
Although Shillito understands why his recommendation was met with scepticism, he says it shows that investors shouldn’t just focus on funds that are currently doing well, but instead should put together a portfolio of holdings that can outperform during different conditions.
He adds that the major reason why it has topped the sector in this year’s poor market is because its manager, Judith Mackenzie, has a very unique style.
“It is always going to look second-best in a very buoyant market, but I hold it because I think it will outperform over a cycle,” Shillito (pictured) said.
“The reason why it has outperformed this year is because Judith MacKenzie manages this micro-cap fund in a very different way to more or less every other smaller companies manager.”“The fundamental difference is that most small cap managers will use certain processes to assess stocks, be it P/E ratios, cash flow or dividend cover, but at the end of the day they are still buying equity shares on an index and thinking, is there a real possibility that these shares will go up?”
Shillito says MacKenzie’s approach is poles apart.
“She knows the share price fundamentals and of course takes them into consideration, but she approaches each company from a private equity mindset. She doesn’t go in wondering what the share price will be in three years’ time.”
“If she thinks the company has a good management and a good product, she will invest capital to try and turn around the business.”
MacKenzie took over the portfolio in February 2011 and Shillito says that she was presented with a very difficult task.
From its launch in September 2008 until the manager's arrival, it was the worst-performing portfolio in the sector, with losses of 13.29 per cent. The average IMA UK Smaller Companies fund returned more than 35 per cent over this period.
However, it has been a second-quartile performer with returns of 59.6 per cent since MacKenzie took over.
Performance of fund vs sector since Feb 2011
Source: FE Analytics
As Shillito told FE Trustnet last year, MacKenzie completely changed the strategy of the fund when she took charge.
By taking a private equity approach, the manager will usually sit on the board of companies that she invests in and will often inject debt into a business to help it turn around.
Because of this, Shillito says returns can at times be lumpy as they are largely generated by sales. However, he adds that this is the type of fund investors should be looking at as it offers a different way to play the UK smaller companies sector.
“Small caps had been having a wonderful time, but have fallen off their perch more recently,” Shillito said.
“There have been a lot of IPOs and also a lot of blue-sky thinking. Also, with the economy looking like it is improving, a lot of investors have been thinking 'let’s just buy small caps because they will benefit'.”
“The chickens have come home to roost for a lot of those managers because they have been buying on sentiment. She hasn’t done that. If you haven’t had that mindset, you haven’t been affected by the change in sentiment.”
Shillito uses PFS Downing Active Management within his £21.9m SGWM Managed fund – it is his fourth largest holding, making up 8.9 per cent of assets. He also owns it in his own ISA.
MacKenzie runs a concentrated portfolio of between 25 and 30 UK smaller companies and she will typically only invest in stocks with a market capitalisation of between £20m and £150m.
She is prepared to take big stock-bets within the fund and her top-five holdings account for 30 per cent of total AUM.
The fund’s largest individual position is Sprue Aegis, which makes up 8.44 per cent of the portfolio. The £115m AIM-listed company focuses on designing, selling and marketing smoke and carbon monoxide detectors for homes.
Our data shows the stock has returned 10 per cent since its first day of trading in March.
Performance of stock vs index since Apr 2014
Source: FE Analytics
Other top-10 holdings include Inland Homes, Tracsis, K3 Business Technology and Scisys.
PFS Downing Active Management has an ongoing charges figure (OCF) of 1.56 per cent.
In an article later this week, FE Trustnet will look at other funds that are currently underperforming but that experts think will outperform over a full cycle.
