Paul Marriage says the decision to hard-close just months before a sharp period of small-cap underperformance and some stock specific issues were the major reasons for the bottom decile performance of his Schroder UK Dynamic UK Smaller Companies fund last year – but the manager, along with leading industry experts, believe the portfolio is set for a reverse in fortune.
FE Alpha Manager Marriage, who runs the four-crown rated fund with John Warren, is highly rated in the industry thanks to his disciplined investment approach and strong long-term track record.
His fund has topped the IA UK Smaller Companies sector since Marriage took charge and comfortably beaten its benchmark after outperforming the index in each calendar year between 2006 and 2013.
Performance of fund versus sector and index over manager tenure
Source: FE Analytics
His stellar track record resulted in a surge of inflows between 2012 and 2014, and led to the group’s decision to “hard-close” at £1.3bn in January 2014. Since then, it has been the second worst performing portfolio in the sector with losses of 9.21 per cent. The average UK small cap fund has broken even over the period.
Performance of fund versus sector and index since Jan 2014
Source: FE Analytics
Schroder UK Dynamic Smaller Companies has more than halved in size to £520m and has since re-opened to investors.
Speaking at the FE UK Growth event earlier this week, Marriage said that the decision to shut the fund was one of the major drivers of his underperformance.
“The closure period was a key one for us in terms of asset reduction from £1.3bn to £500m and I can’t try and pretend that was an enjoyable experience. We closed and small-caps peaked two weeks later after a period where they had been absolutely phenomenal,” Marriage said.
According to FE Analytics, during the five-year period between the market bottom after the financial crisis and March 2014, UK small-caps delivered returns of close to 250 per cent.
Marriage’s fund was one of the prime beneficiaries of this, gaining close to 440 per cent over the period.
However, concerns over valuations and the strength of the economic recovery has led to significant outflows from UK smaller companies, with many investors choosing to hide in the relative safety of cheaper large caps.
The hard closure of the fund compounded the effect for Marriage, as it forced some professional investors to remove the fund from their buy-lists. The outflows came just as the market started to fall, which Marriage says made running the fund particularly difficult. He says his experiences over the past 12 months or so mean that he would be unlikely to hard-close the fund again.
He added: “It’s a nice problem to have, getting to £1.3bn, but we would have to address it in a better way for investors because what happened last year really wasn’t that good.”
Apart from the hard-closure, he says there were other issues such as stock disappointments.
“In late 2013, we took a big stake in Stock Spirits, the Polish vodka company. There was a price war with Polish Vodka, there was a tax increase which we knew about and then there was a war in Ukraine.”
“Clearly, you wouldn’t have bought a Polish vodka business if you had known the geo-political landscape would change so much – but that is the nature of investing.”
The £398m market-cap company, which is still one of Marriage’s largest holdings, is down 30 per cent over the past year. He confirmed he is in the process of reducing his exposure.
Performance of stock versus index over 1yr
Source: FE Analytics
Marriage admits mistakes were made in the aftermath of the fund’s AUM ballooning by more than 10 times between March 2012 and January 2014.
“I would accept that when we had a lot of money coming in, we took a little too much risk and bought a couple of big positions in small stocks and I had to work hard to get out of those,” he said.
The manager is quick to point out that his underperformance has had nothing to do with his move to Schroders however, stressing that he hasn’t had to integrate any part of his investment process with other teams.
Marriage says there have been a number of added benefits as a result of the move, such as the better execution, distribution and dealing at his new group. F&C’s Scott Spencer, who attended the event, points out that without the help of Schroders’ extensive dealing team, it could have been even worse for the fund.
Nevertheless, Marriage says that market liquidity was a nightmare last year.
“No-one has sold £700m worth of small-caps in a year like we did. It wasn’t much fun but we’ve done it.”
While the manager is happy with his portfolio, he admits that there are certain stocks he would like to sell more of when he is able to.
Andy Parsons, head of research at The Share Centre, who also attended the event, says investors should trust that Marriage has raised the appropriate portfolio liquidity needed. Marriage also says that the immediate outlook looks far more positive in that regard.
“At the moment, small-caps are quite liquid again,” said Marriage. “Is that evidence that people are coming down the cap-scale because they see value? Maybe. It’s quite interesting because we are starting to see some bids on the screen for second hand stock.”
Performance since March 2014
Source: FE Analytics
Like other experts such as Hargreaves Lansdown’s Mark Dampier, he says the outlook for small-caps is looking positive following the sector’s tough run. He admits though that there is likely to be continued volatility.
“Small-caps are cheap relative to large-caps but the crux of it is, for the first time in a long time, earnings forecasts are realistic and in some cases are too low because most of the companies we are meeting are very positive.”
“Now it seems like there is an opportunity to close the gap. Small-caps are risky, illiquid and difficult to trade – we know all that stuff – and do you want to buy that into a UK election, especially a fund like this which has 63 per cent exposure to the UK economy? Maybe not.”
“I can completely understand that right now it is only for the brave, but usually you get past the election and people will start to look and see that large-caps look a bit expensive.”
A number of the delegates at the FE UK Growth event say that the fund now looks very interesting due to its smaller size, experienced management team and attractively valued asset class.
Spencer says the fund is now back on his radar while Parsons holds Marriage in the highest regard as a result of his upfront and honest self-appraisal of his performance over the last year.
Premier’s Simon Evan-Cook, who sold out of the fund a few years ago due to size concerns, is also positive but isn’t expecting an immediate rebound.
“I think Marriage is very experienced and I don’t think what has happened over the last year makes him a bad manager. On the contrary, it should make him better as he can learn from it,” Evan-Cook said.
“My take on it would be that the worst of the storm has passed. The reason we sold in the first place was because it was £800m at the time and assets were still flooding in and there were no signs of that stopping – plus we were worried about smaller companies in general.”
“I think a lot of the hot money has come out now and going forward it looks like an investible fund again, but the manager has more to do.”
While still dealing with outflows, Marriage is more confident as well.
“I’m a bit more positive than I have been for a while. It’s been a tough period for the fund and a relatively tough period personally as it isn’t much fun to build something up and watch it get deconstructed in front of you – but we have got through it,” Marriage said.
“Small-caps are an interesting place versus other asset classes right now. We have been through a catching breath phase where earnings and valuations will become a bit more realistic. It is also a bit of a Millwall phase – 'No-one likes us but we don’t care'. Us small-cap managers will crack on and see how it pans out in the end.”
Schroder UK Dynamic Smaller Companies has an ongoing charges figure of 0.91 per cent.