Fund size can be a big issue when it comes to smaller companies funds as small-caps tend to be less liquid. Therefore, the larger a portfolio gets the less it can hold in the tiniest members of the index, which could affect relative performance.
As FE Trustnet highlighted earlier this morning, concerns have been raised about the size of three of the best known smaller companies portfolios in the sector; namely Harry Nimmo’s Standard Life Investments UK Smaller Companies fund, Giles Hargreave’s Marlborough Special Situations fund and Dan Nickols’ Old Mutual Smaller Companies fund.
All three are FE Alpha Manager ‘hall of famers’ and it is no surprise they have attracted a lot of investor attention given the strong performance of their funds over the years.
Performance of fund versus sector over 10yrs
Source: FE Analytics
However, all three managers are running close to or more than £1bn across their strategies which some warn may impede the chances of future outperformance.
While Nimmo, Hargreave and Nickols deny they face any capacity constraints, Premier’s Simon Evan-Cook said he would prefer to back funds with a smaller AUM at this point in time as they give more genuine exposure to the asset class.
“They have all proven they are excellent managers and their funds are not ‘uninvestable’ by any stretch of the imagination. However, from our perspective, we would prefer to buy funds which can decent positions in their best bets without being constrained by size,” he said.
With that in mind, we highlight three potential alternatives to the sector’s top-performing giants for those who are concerned about size and potential liquidity restrictions. We have deliberately focused on open-ended funds in this article, but we will look at small-cap investment trusts in more detail next week.
One of Evan-Cook’s favourites is FE Alpha Manager Paul Spencer and Richard Bullas’ Franklin UK Smaller Companies fund, which is certainly one of the more nimble in the sector with its AUM of £180m.
The duo only took charge of the fund in June 2012 as it had previously been managed by the long-serving Stuart Sharp, though their predecessor’s portfolio construction had meant it had been a serial underperformer relative to its peers and benchmark.
Nevertheless, the two managers “drastically” overhauled the portfolio by removing illiquid micro-caps, reduced the number of holdings and ditched the previously high-exposure to commodity related companies.
These changes have paid off so far.
According to FE Analytics, Franklin UK Smaller Companies sits in the top quartile since Bullas and Spencer have been at the helm. It has returned 98.73 per cent over that time, beating the Numis Smaller Companies ex IT benchmark by 25 percentage points in the process.
Performance of fund versus sector and index under Bullas and Spencer
Source: FE Analytics
The fund outperformed both the sector and index in 2013 and 2014 and is currently the peer group’s second best performer so far in 2015 with gains of 20.02 per cent.
The manager’s approach revolves around buying high quality growth business, with the caveat that they won’t overpay for those characteristics. They currently hold 45 per cent in industrials and count the likes of Clipper Logistics and Topps Tiles as top-10 positions.
Its ongoing charges figure (OCF) is 0.84 per cent.
AXA Framlington UK Smaller Companies
Another option could be the five-crown rated AXA Framlington UK Smaller Companies fund, which is managed by Henry Lowson and is just £170m in size.
Lowson doesn’t have the longest of track-records (he took charge of the portfolio in May 2012) but works closely with AXA IM’s highly-rated UK equity team, which includes the experienced Nigel Thomas.
On top of that, he has turned in good numbers over his relatively short tenure.
According to FE Analytics, AXA Framlington UK Smaller Companies has been a top decile performer in the sector over that time with returns of 98.36 per cent. Its benchmark – the FTSE Small Cap ex IT index – has gained 80.92 per cent over the period in question.
Performance of fund versus sector and index under Howson
Source: FE Analytics
The fund was top quartile in 2013, 2014 and is so far sitting in the top-quartile year to date.
It has also been top quartile performer in relation to its annualised volatility, risk-adjusted returns (as measured by its Sharpe ratio) and maximum drawdown – which shows the most an investor would have lost if they had bought and sold at the worst possible times – since Lowson became manager.
These decent capital preservation characteristics stem from the manager’s approach, which like households names such as Harry Nimmo, revolves around a GARP (growth at a reasonable approach) strategy.
Lowson also keeps capacity in mind as he told FE Trustnet that if the fund were to breach the £500m barrier then he and the group would closely monitor liquidity. The fund has an OCF of 0.85 per cent.
The final fund on this list is also five crown-rated but weighs in at just £60m – namely Simon Moon’s Unicorn UK Smaller Companies fund.
As a group, Unicorn is renowned for its expertise in small-cap investing and Moon (who now also co-manages the Unicorn UK Income fund along with Fraser Mackersie) says he has been “fully indoctrinated” into the successful strategy created by the late star manager John McClure.
It is a high conviction approach (he holds just 33 companies) with low turnover. The stocks that fit his criteria are those that are profitable at the time of investment, have strong balance sheets, have significant market share – usually in a relatively niche industries – and are led by a strong management team.
Moon, like McClure before him, will also only ever invest in companies where he has a clear understanding of their business models.
Unicorn UK Smaller Companies has been a top quartile performer since Moon took over in March 2013, beating both the sector and its Numis Smaller Companies ex IT benchmark by around 20 percentage points with its returns of 58.85 per cent.
Performance of fund versus sector and index under Moon
Source: FE Analytics
It fared phenomenally well in 2013’s strongly rising market with gains of 56.97 per cent but gave back some of that performance in the more difficult conditions of 2014 with third quartile losses of 2.10 per cent. It is outperforming so far this year, though.
Like Lowson, however, Moon has been one of the best performers in regards to his annualised volatility, Sharpe ratio and maximum drawdown during his tenure on Unicorn UK Smaller Companies.
The fund has an OCF of 0.83 per cent.
