Since the launch of his popular CF Woodford Equity Income fund earlier this year, the FE Alpha Manager has talked passionately and at length about these sorts of companies and why he holds them in his monthly commentaries and portfolio updates.
However, given that his fund now stands at £3.4bn, they can only make up a relatively small proportion of his portfolio as they are usually micro-caps which therefore tend to be quite illiquid.
One fund which also rates university spin-out businesses, however, but is nimble enough to take more meaningful positions in those stocks is the five crown-rated Baillie Gifford Global Discovery fund – which has an AUM of just £150m and is headed up by John MacDougall and FE Alpha Manager Douglas Brodie.
Speaking at a conference in Edinburgh last week, MacDougall explained that while they are by no means imitating Woodford’s ideas, there are a number of overlaps between their respective portfolios.
“There are a few names on that list which Neil Woodford has within his fund,” MacDougal (pictured) said. “In general, in terms of those Oxford biotech innovation parks we do have a fair bit of exposure and a lot of that comes from holding IP Group.”
“Because we have been long and quite significant supporters and have built up a good relationship with the company here at Baillie Gifford, we get to hear about more and more of these ideas coming through and then we can go and meet them ourselves and potentially invest.” He added: “We therefore hold a few IP spins out within the fund.”
IP Group, which sits in the FTSE 250 and has a market cap of £990m, is MacDougall and Brodie’s second largest holding making up 4.4 per cent of their assets. As a point of comparison, it is Woodford’s fortieth largest position making up 0.92 per cent of his fund.
IP Group, which is an intellectual property business investing in technology companies, has performed very well over recent years and Baillie Gifford, as a business, has invested in the stock since its flotation in October 2003.
Performance of stock versus index over 3yrs
Source: FE Analytics
McDougall also holds biotech company 4D Pharma, commercial cleaning firm Xeros Group and chemical company Velocys within his portfolio, which all feature in CF Woodford Equity Income and are IP Group spin-outs.
Combined with IP Group, those four stocks make up 8.3 per cent of the Baillie Gifford fund, while they account for just 1.82 per cent of Woodford’s assets.
Baillie Gifford Global Discovery doesn’t sit in the UK sector, however. MacDougall, who also runs a number of Japanese mandates at the group, admits that it felt like a strange decision to hold so much of his fund in UK small-caps, but he is glad he took the decision.
“The UK makes up 27 per cent of the fund,” he said.
“This is all very much bottom-up, but it reflects the businesses we are finding attractive. I guess for someone who has come from an Asian background, initially when we were putting the portfolio together and some of the team were saying we need to hold X,Y and Z, I thought this cannot be true, the UK is dead.”
“There can’t be this many innovative businesses in the UK? But, over the last three years I have been really, really pleasantly surprised at what has been going on in the lower levels of the UK’s market cap.”
“Obviously, the US is still the best in terms of taking leap with the initial spark of inspiration, getting the financing sorted and getting listed but while the UK is a bit behind, it isn’t far behind. I think that link, particularly with taking university ideas and commercialising them, has improved a lot over recent years.”
“That ties in with why IP Group is one of our largest holdings as it is the company which has first refusal on any technology coming out of UK universities.”
The manager said that when he and Brodie launched the fund in May 2011, they didn’t want it to be like other smaller companies funds available to investors.
“The reason we didn’t call it the Baillie Gifford Small Cap fund and went for the Discovery name is because we are looking for not just small companies, but for something we call immaturity.”
“I know that has bad connotations, but we want a small business which is at an immature stage of its development but can become much bigger and developed in the long run, rather than just liking small-caps per say.”
They categorise these sorts of companies as those that have innovative and entrepreneurial management teams who, in turn, are trying to change the world in some way. They are growth investors who like to “run their winners”.
This strategy has worked very well so far as, according to FE Analytics, it has been the eighth best performing portfolio in the 220-strong IMA Global sector since its launch with returns of 54.65 per cent.
As a point of comparison, the MSCI World Small Cap index has returned 36.68 per cent over that time.
Performance of fund versus sector and index since May 2011
Source: FE Analytics
The fund turned in top quartile returns in the rising markets of 2012 and 2013, but has fallen into the bottom quartile this year with its returns of 2.2 per cent. However, MacDougall attributes those lacklustre returns to the nature of the companies he owns.
Performance of fund versus sector and index in 2014
Source: FE Analytics
“Up until spring, the fund was doing pretty well and then over the last six months, as you will be aware, people have been worrying about where the world is going and there has been more of a risk aversion period than there has been over the past three and a half years,” MacDougall said.
“We except that, in general, people will look at these business and see them as riskier than the average as we have a lot in biotech and internet-type stocks, and in the spring there was a heavy sell-off in these stocks – a number of which have come back quite strongly.”
“But it was more about a period of global risk-off sentiment [that] would be the common factor for that underperformance.”
Given its £150m size, Baillie Gifford Global Discovery has gone under the radar of most advisers and retail investors. However, Attivo’s James Swaby recently told FE Trustnet that he had starting buying it for his portfolios as it is an “ideal long-term holding”.
The fund has a clean ongoing charges figure of 0.78 per cent.
