A focus on “genuine growth” is what allowed many of Unicorn UK Growth’s holdings to “survive and thrive” last year – even though they operated in some of the sectors hardest hit by the lockdown, according to the fund’s managers Fraser Mackersie and Alex Game.
Most types of growth strategy have delivered strong returns over the past decade, whether that is buying loss-making businesses that are investing heavily for the future or holding ‘expensive’ quality companies that deliver steady and dependable returns.
However, Mackersie and Game prefer to focus on what they call “genuine growth” stocks.
“We find companies that are capable of delivering very strong organic growth over an investment horizon of three to five years,” said Mackersie.
“The growth must be consistently above the levels you see in the market. Companies in that respect will be profitable at the point of investment, generating cash, have strong balance sheets and may pay a small dividend.
“I guess the key here is that they will generate sufficient cash to reinvest and continue to fund their own growth. If acquisitions come along that are sensible, either a bolt-on or something more meaningful, we'll take a view on that.
“But in order for us to invest, we really need to see that the core growth drivers are there.”
Mackersie and Game start their process by running a quantitative screen that analyses numerous metrics such as earnings growth, debt, free cash flow and return on invested capital. Game said the PEG (price/earnings to growth) metric is particularly important as it helps them identify how companies are valued relative to the growth they are delivering.
“And then beyond that, we're looking for a number of key characteristics: market leaders, high margins, barriers to entry,” he added. “We like companies with fairly predictable levels of earnings, so that all plays into the investment appraisal.”
The aim of this approach is to put together a portfolio of companies that can consistently deliver double-digit earnings growth. Game said that although he and Mackersie do not have any special ability when it comes to predicting share-price moves in the short term, they are confident that a portfolio of companies with growing and compounding earnings will deliver strong returns over time.
This strategy has resulted in Unicorn UK Growth having a high exposure to technology and computer services, even though this makes up a relatively small part of the UK market. This area fared particularly well last year, with many companies unaffected and even benefiting from the economic lockdown.
However, Game said the focus on market leaders with strong balance sheets meant that he and Mackersie were also confident that the holdings in some of the areas hardest hit by the lockdown would make it through the pandemic in a strong position.
“We would call them ‘survive and thrive’ companies,” he said. “What's interesting and quite exciting for us is the growth opportunity for these businesses is now very strong.
“Lots of their competitors have fallen by the wayside over the last 12 months, they've taken on lots of debt just to survive.
“While it’s been a very tough period, we think these companies are going to be on the front foot in terms of reinvesting to drive growth as and when conditions improve. I think the growth outlook for lots of those businesses is very strong.”
One of these “survive and thrive” companies is The Fulham Shore, which owns The Real Greek and Franco Manca chains. Although most of its restaurants were closed last year, Game said the business still did reasonably well thanks to the takeaway and delivery service.
Performance of stock since IPO
Source: FE Analytics
“You might have eaten at Franco Manca or enjoyed its pizzas, which are very good quality and decent value,” he continued.
“But when you look at the growth outlook for that business, it is executing a fairly disciplined rollout.
“It is getting so many property opportunities come to its front door in terms of acquiring sites on very good deals where the landlords will forego a period of rent or part-fund some of the upfront capex.
“Some of the deals coming out of this period to expand are really attractive.”
Data from FE Analytics shows Unicorn UK Growth has made 208.52 per cent since Mackersie joined in March 2011, compared with 92.13 per cent from the IA UK All Companies sector and 79.09 per cent from the FTSE All Share.
Performance of fund vs sector and index over 10yrs
Source: FE Analytics
The IA UK Smaller Companies sector made 198.02 per cent over this time.
The £107m fund has ongoing charges of 0.82 per cent.