Schroder UK Dynamic Smaller Companies has certainly seen its ups and downs since FE Alpha Manager Paul Marriage took over the helm in 2006. 
The star manager, who is renowned for his strong long-term track record, saw money gradually pile into the small-cap fund, which has been co-managed by fellow FE Alpha Manager John Warren since 2010.
Formerly called Cazenove UK Smaller Companies, the small-cap fund achieved a top-decile return of 35.8 per cent in 2006, outperforming its sector and benchmark by 11.9 and 12.93 percentage points respectively.
The fund then continued to deliver a strong performance over the years as it gained popularity and as small-caps grew in favour during the UK bull market in 2012 and 2013.
In fact, from the start of Marriage’s tenure to the end of 2013, the fund returned 245.6 per cent, which was more than double the returns of its sector average and four times more than its FTSE Small Cap benchmark.
Performance of fund vs sector and benchmark from management tenure to 2014
Source: FE Analytics
However, with Schroder UK Dynamic Smaller Companies’ boost in popularity came a huge increase in inflows. Between the end of January 2013 and the end of January 2014 the fund increased in size by more than 72 per cent from £366m to £1.3bn.
While that figure includes strong NAV returns, the fund was consistently among the sector’s best sellers.
Simon Evan-Cook, multi-asset manager at Premier, sold his exposure to the fund shortly before it grew to £1bn in size, due to fears that it had grown too large too quickly, and that too much hot money was flowing into the UK small-cap space.
“We sold out at that point and went into a smaller fund. Since then that fund has struggled as money came out of that fund and money came out of the type of stock it invested in, but to me it seems like the worst has passed,” he said.
“I think a lot of the money that was chasing that type of fund has now disappeared. The manager himself hasn’t changed, he still seems to be a very good fund manager. Our concern was always that the size of the fund made it too difficult to manage, particularly given the pace of inflows.”
In January last year, Schroders announced that the fund was to hard-close at the end of the month as a result of strong inflows and to protect the returns that existing investors had accumulated.
However, money subsequently poured out of the fund as groups were forces to remove it from their buy lists and the portfolio nearly halved in size between the end of January and when the fund was re-opened in October last year.
Size of fund over the last 3yrs
Source: FE Analytics
The outflows had a very poor effect on the fund’s performance as smaller companies fell increasingly out of favour last year as investor’s looked to de-risk their portfolios after stellar gains from the asset class and because macro headwinds were increasing.
This meant Marriage had to sell (in order to meet redemptions) into a sharp falling market. All told, along with a few stock disappointments like Polish Vodka company Stock Spirits, the fund was the sector’s fourth worst performer in 2014 with losses of more than 8 per cent.
Tristan Scrivens, company director at Elm Financial Management, said: “The fund is a more manageable size now. [Marriage] must have struggled with having so much of an inflow and so quickly as well.
“To place that money somewhere and to get a return on it would have been quite tough considering they were applying bottom-up strategy and assessment on those companies. That’s a lot of money to place.”
Since October, the fund has continued to shrink in size and currently stands at £533m. Over the last 12 months, Schroder UK Dynamic Smaller Companies has achieved a bottom-quartile total return of 10.16 per cent, underperforming its peer average in the IA UK Smaller Companies sector by 3.29 percentage points.
Performance of fund vs sector and benchmark over 1yr
Source: FE Analytics
Is this drastic dip in performance a warning sign for investors to sell out of the fund? Martin Bamford, chartered financial planner and managing director at Informed Choice, doesn’t think so especially given his positive outlook for UK small-caps.
“If you’re already an investor in Schroder UK Dynamic Smaller Companies, you should probably stay put,” he said.
“The sector as a whole has fallen out of favour with investors in recent months, but small-caps should reap the rewards as the British economy continues to recover.”
“Schroder appear to be taking a sensible approach with this fund, closing it to new money when it was growing too quickly and reopening it when market conditions changed. I wish more fund providers would respond to capacity constraints in such a proactive fashion, rather than arguing their strategy can cope with multi-billion pound portfolios.”
Meera Hearnden, senior investment manager at Parmenion, says that one of the fund’s desirable traits is its genuine bias towards small-caps.
Smaller companies have performed far better than their large-cap rivals so far this thanks to the election result and an improving UK economy. What’s more, many expect this to continue given the macro-headwinds facing the very international FTSE 100 index and the relatively low valuations on offer in the small-cap space.
Performance of indices in 2015
Source: FE Analytics
She says that, while many smaller companies funds hold substantial weightings in mid-caps, at least 80 per cent of Schroder UK Dynamic Smaller Companies is invested in UK companies that are in the bottom 10 per cent of the UK stock market at any one time.
“The fund has had a difficult period but Paul Marriage is one of few true small-cap managers,” she explained.
“Many small-cap managers have sizeable weightings in mid-caps which have held up better but these funds are not true small-cap funds. Although the fund has suffered a setback in the last year, this doesn't make Paul marriage a bad manager. Indeed, he has shown to demonstrate good stock picking skills, and while his strategy comes with higher volatility, his long term track record is very good.”
“Investors who favour his strategy, and are prepared to put up with the additional volatility may wish to consider adding a position following the weakness.”
The fund is likely to be favoured by the stronger-stomached investor, as it has a high conviction portfolio of 56 stocks. Also, it holds large proportions of very small companies in its top 10 holdings – the fund’s largest holding is in Johnson Service group, which is an AIM stock that is £290m in size, and Marriage holds approximately 8 per cent of the company.
There are other examples of this high concentration, such as his 7 per cent stake in Smart Metering Systems and 11 per cent ownership of British Polythene Industries. Of course it is unknown whether this current concentration is a result of the outflows or not, but Evan-Cook says it isn’t too much of an issue.
“We would prefer fund managers to be holding smaller stakes in companies as that gives them the flexibility, not just to be able to sell their stakes reasonably easily if they need to, but also build up new stakes that form a significant proportion of their fund,” Evan-Cook said.
“I wouldn’t necessarily say [holding large proportions of companies] would be a concern for us, but we would prefer to see smaller stakes in a fund.”
While the fund’s large stakes in companies could cause liquidity concerns for some investors, Bamford argues that those who are invested in the fund are more likely to have a greater tolerance for risk than UK equity investors in general.
“Marriage has a strong focus on product, market, margin and management when choosing companies, and has a robust process for selecting stocks for the fund. For a long-term investor – and we should all be long-term investors – this fund has decent potential to deliver.”
While Scrivens doesn’t currently use Schroder UK Dynamic Smaller Companies, he has used it in client portfolios before and says it’s still a strong smaller companies fund.
“As long as you have a diversified portfolio, I would hold it. The whole idea is you spread risk, so when something tanks, as this fund perhaps has done lately, something else is usually going up at the same time.”
“Smaller companies are good to hold in general just to buffer things up, and if you’re putting money in to this fund at the moment, you’re effectively buying in a bit cheaper.”
Schroder UK Dynamic Smaller Companies has a clean ongoing charges figure (OCF) of 0.91 per cent.