Fund managers tend not to talk publicly about how much they earn and it isn’t difficult to see why. As one of the highest-paid professions around, declarations of remuneration will only add weight to the argument that the end investor is being short-changed considering the large fees they are charged for performance that is often underwhelming.
However, it is for this reason that Dan Vaughan of VT Teviot UK Smaller Companies has admitted that the performance he delivered at certain points during his career as a fund manager wasn’t as strong as it perhaps should have been.
“I ran £1.5bn at Columbia Threadneedle for seven years and was paid handsomely for delivering 2 to 3 percentage points of outperformance per annum, but I was severely impeded by the fact that I was running too much money,” he said.
“My average unit holding would be £20m to £30m and therefore I was constantly driven up the market cap scale and pushed away from doing what I enjoyed most, because investing in small caps below £200m is where the real value is to be added.”
This is what motivated him to set up Teviot Partners in 2016. The manager carried out research into the best-performing small-cap managers and found that those running less than £500m tended to produce 8 to 9 percentage points of outperformance per annum, but as assets moved towards £1bn it degraded towards 3 to 4 percentage points, then down to 2 to 3 percentage points when they moved above £1bn, which was his experience at Columbia Threadneedle.
Vaughan gave the example of investing in logistics provider Wincanton to show how liquidity can work against you when assets get too large.
“If you went from its low point in 2012 [when it had a market cap of about £50m] to its peak in 2017 [when it had a market cap of about £375m] with a £1m holding, you'd have made about seven times your money. If you had a £30m holding, you'd have made less than three times your money because of the time it would have taken you to get invested and then disinvested.
“Not only that, but you can then rotate your money more quickly into the next stock and accelerate your returns. And that's a key element of liquidity for us.”
As a result, Vaughan will never let assets under management in this strategy get beyond £500m.
“It is some way off as we are at £150m or so now,” he said. “But we need to be held to account because we believe returns will start to be impaired when we get close to that amount.”
However, the manager said one way in which investors in his fund will benefit from higher assets under management is through lower costs, with Vaughan hoping to reduce the fund’s ongoing charges figure (OCF) from 0.85% towards 0.75% as he builds scale.
While this may sound like what investors want to hear, most would probably be happy paying slightly more in charges if they are benefiting from strong returns. So far, VT Teviot UK Smaller Companies is delivering in this regard as well, as it is the best-performing fund in the IA UK Smaller Companies sector since launch in August 2017: it is up 73.7% over this time, compared with gains of 15.4% from its peer group composite and 6.6% from its Numis Smaller Companies 1,000 ex ITs benchmark.
Performance of fund vs sector and index since launch
Source: FE Analytics
Vaughan attributed this to his value stance, pointing to his investment in wholesaler Kitwave at IPO in 2021 as an example.
“Everybody else was buying Victorian Plumbing and Made.com – stocks that benefited from the online retail boom,” he said.
“We went with a boring food and drink wholesaler that had a tough time because of Covid. But its shares are now up 60% since IPO and the Made.coms of this world came undone and went very quickly. Being contrarian has certainly been a benefit for us.”
Vaughan admitted that, if you listen to the news, there are plenty of reasons why you wouldn’t want to invest in his area of expertise – small caps tend to be volatile, illiquid and economically sensitive, while investors continue to pull money out of the UK.
The manager accepted earnings growth is going to be hard to come by, which is why he is defensively positioned, with an overweight in energy producers as a way of coping with the inflationary backdrop.
However, he said that he is ready to move the portfolio into more cyclical areas as soon as he sees signs of the economic recovery coming through.
“In the meantime, given the valuations and the yield support, there is limited downside,” he added.
“And I think recent M&A shows other people are going to take advantage if investors don’t.”