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Threadneedle manager: ‘Bond funds are risky, that’s why my pension is in smaller companies’

22 October 2021

Columbia Threadneedle manger James Thorne tells Trustnet why small-caps are better than bonds if investors can hold for the long term.

By Jonathan Jones,

Editor, Trustnet

Smaller companies are the best place for investors with the ability to leave their cash alone for the long term. This may not be a ground-breaking statement, but is easily forgotten by the events of the past decade.

Indeed, over 10 years, the large North American technology stocks have dominated investors’ attention, as well as market returns. Since 2011, the S&P 500 has been the best-performing index, returning 387.8% while leading the MSCI World index higher. During this time it has beaten the Numis Smaller Companies excluding Investment Companies index of UK small-caps by 173 percentage points.

However, going back 20 years, the UK small-cap benchmark has beaten the North American index by more than 200 percentage points, as the below chart shows.

Total return of indices over 20yrs


Source: FE Analytics

James Thorne, manager of the Threadneedle UK Smaller Companies fund, calls this the “smaller company effect”, which has proven to work since the Second World War.

“We aim for 15% returns per year, broken down by a long-run average 6% from equity markets each year, followed by a 4% small company effect and finally 5% from active management, which pretty much our fund has done over the past decade,” he said.

Indeed, the £260m portfolio has been a top-quartile performer among its IA UK Smaller Companies sector peers, returning 361.5% over the past decade, or an average of 16% per year.

Below, the manager explains how his fund has achieved this, why it tends to struggle during value rotations and why smaller companies funds are less risky than bonds.

Total return of fund vs sector and benchmark over 10yrs


Source: FE Analytics


How do you pick stocks?

We look for sustainable opportunities and put together a portfolio that is uncorrelated, with the lowest risk. To do this, we spend a lot of time looking at businesses and benchmarking what has worked in the past against what is working today.

We like businesses that have a proven business model, usually in the UK, that they can take to the rest of the world. Ultimately we want to buy quality growth companies before they become labelled as such. Sometimes we will be a bit early, but that is okay.


Why should investors pick your fund?

Columbia Threadneedle is a large business and there is a large resource here but we are still agile and disciplined in how we invest. We do not get too emotional and are still very driven and really enjoy the job, so are relentless at looking for new businesses.

Small-cap investing is mainly about the process, which I have explained above, and then having the energy to do the job.


What have been your best and worst calls this year?

Future plc has been the best. It is a content owner of consumer goods and we invested in it a long time ago, but over the past 12 months it is up 81%, going from £19.50 to £35.40 per share.

We think there is a long way to go in that business and are happy to run our winners. When we first invested it had a market capitalisation of £400m and it is now worth £4bn.

The worst was James Fisher – a specialist maritime engineering business. It fell from £12.50 to around £7.74 per share. It was primarily in the oil and gas sector, which has been out of favour, but is also one of the major players in offshore wind engineering and maintenance and has some interesting technology. We think it can reposition itself quickly.

The company has a lot of debt still and it is hard to know if the business model will perform well in the next six or 12 months, but I think there is still opportunity there.

What is the most exciting stock in the portfolio?

1Spatial is the second-largest holding in the portfolio and we own 20% of the shares, which is our limit. We have been committed to it for several years as it has gone through a restructuring.

Geospatial data has to be cleaned and put into the same format as it is moved around and 1Spatial has the technology to do that. It is unusual for a £50m company to have Google, the Ordinance Survey and a number of UK utility companies as customers.


How risky are smaller companies?

A lot of my pension is in my fund as I think bond funds are really risky. If the yield curve takes off and bonds were my pension, I could lose a large chunk of my money and not get it back. In my mind, that is incredibly risky.

Volatility is potentially higher in smaller companies, but it doesn’t matter if you have a longer than 18-month time horizon because that is the time during the past seven recessions that small-caps underperform the wider equity market. Then you recover all of that in the following five quarters, so the all-round trip is two years.

In terms of the fund, I structure it as if it is my own money, because partly it is. If a company doesn’t work, it will be kicked out of the portfolio, which means in reality the fund is not that high risk.


Do you incorporate environmental, social and governance (ESG) in the portfolio?

We do not formally have a set target, but I am the deputy manager of our UK sustainability fund, having previously run it for about three years.


Your fund as in the bottom quartile of its sector in 2018 and is below average this year. Does it not perform well in value recoveries?

In a value rotation we would hope to be slightly ahead of the benchmark, but we are not aiming for a first quartile return. We are in-line this year and I feel we are in a great position to kick on from here.

In 2018 there were other issues in there where we made a couple of errors as we thought some businesses were protected by regulation and it turned out to be the other way around. We have corrected some things since then.


Are there any sectors you avoid?

There are lots of areas that I don’t massively like investing in. It starts with financials because it is dominated by the incumbents and the cost of capital is very high. We also struggle to find companies within real estate.

Another area is mining and oil and gas, which used to be an exciting area. Historically junior companies proved up an asset and a major would either buy it or put in capital to develop it, but that is not happening anymore.


What do you do outside of fund management?

I studied oceanography at university so have always liked the water. I have a dingy boat and I am teaching my daughters to sail. I am not particularly good, but I enjoy it. I also surf and row.

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Data provided by FE fundinfo. Care has been taken to ensure that the information is correct, but FE fundinfo neither warrants, represents nor guarantees the contents of information, nor does it accept any responsibility for errors, inaccuracies, omissions or any inconsistencies herein. Past performance does not predict future performance, it should not be the main or sole reason for making an investment decision. The value of investments and any income from them can fall as well as rise.