Small-cap strategies such as Marlborough Special Situations, Merian UK Smaller Companies Focus and R&M UK Equity Smaller Companies appear to have consistently benefitted from very high levels of manager skill over the long run, if the information ratio is anything to go by.
The information ratio aims to measure the success of a manager’s active decisions away from the benchmark for each unit of extra active risk taken on. The higher the information ratio, the better; analysts in FE Invest consider a figure of 0.5 to reflect good performance, 0.75 very good and 1 outstanding.
In this series, we have previously looked at the IA UK All Companies and IA UK Equity Income funds, as well as the IA Global sector.
This final article takes a closer look at the five-year information ratio of all the funds in the IA UK Smaller Companies sector with a track record going back to at least the start of 2007 and an r-squared ratio to the Numis Smaller Companies + AIM Excluding Investment Companies index of at least 0.6 (to make sure the results are statistically significant).
But rather than just consider the most recent five-year period, we used rolling periods going back to the start of 2000 (or the funds’ full history, if shorter) to find the average information ratio and ensure any strong performance has been seen over the long term.
Rolling five-year information ratios of Merian UK Smaller Companies Focus and IA UK Smaller Companies sector
Source: FE Analytics
In contrast to some of the other peer groups we have examined in this series, the IA UK Smaller Companies sector has several funds with strong rolling information ratios and four fall into the ‘outstanding’ bucket.
The fund in the chart above scored the highest in this research: Merian UK Smaller Companies Focus, which posted an average ratio of 1.60 compared with just 0.38 from its average peer.
The £374.1m fund has been managed by Nick Williamson since January 2016, with FE Alpha Manager Daniel Nickols being at the helm before this. However, Williamson is on sick leave until the end of September.
It is top-decile over the three, five and 10 years to the end of May 2019, making 516.20 per cent over the latter period (compared with 290.22 per cent from the sector).
Analysts in the FE Invest team, which has Merian UK Smaller Companies Focus on its Approved List, said: “Despite having a relatively short lead manager track record, Williamson is able to leverage off the well-established Merian philosophy and process, which is to outperform in all phases of the economic cycle by investing in businesses that will do well given the current environment.”
However, they also added that the portfolio has a relatively high conviction approach (holding between 60 and 70 positions), large holdings and exposure to micro caps, AIM and unlisted companies, which mean investors should be aware of the likelihood of increased volatility.
In second place with an average rolling five-year information ratio of 1.27 is R&M UK Equity Smaller Companies, headed up by FE Alpha Manager Daniel Hanbury. Between launch in November 2006 and the end of May, it made a 296.45 per cent total return, ranking it ninth out of 38 peers.
Hanbury runs the portfolio using River and Mercantile’s PVT philosophy, which aims to maximise returns and minimise risk by focusing on potential (the investment dynamic that will create value for shareholders), valuation (the gap between the stock market price and the medium-term worth of the company) and timing (to optimise the entry and exit point of investments).
Source: FE Analytics
In an outlook at the end of 2018, the fund’s manager noted that the economy appears to be in the later stages of the cycle while trade wars and a global tightening of financial conditions need to be watched.
“In the later stages of the stock market lifecycle it requires a nimble approach to stock selection to take opportunities in an ever-changing market environment,” he added.
“What does not change, however, is that stocks are selected via our disciplined investment process which generates the opportunity to deliver alpha. Our PVT investment philosophy provides a dedicated focus to investing in firms with high potential to create significant shareholder value, when bought at attractive low valuations and at the right time.”
In third place in this research is Merian UK Smaller Companies, which has an average information ratio of 1.22. It is managed by Daniel Nickols and made a 1,052.65 per cent return between launch in Feb 2001 and the end of May 2019 – the highest return in the IA UK Smaller Companies sector over this period.
The approach behind the fund has developed over 20 years and combines top-down economic analysis with in-depth stock selection to find attractive companies based on their view of economic cycle's current positioning.
Analysts at Square Mile Investment Consulting & Research, which give Merian UK Smaller Companies an ‘AA’ rating, said: “Nickols is conscious that the attributes the team seek in companies tends to lead the portfolio to have a bias towards growth. Nevertheless, given that the investment process is structured in order to have a consideration of the broader economic backdrop, the manager has the flexibility to adjust the portfolio’s positioning to capitalise on more defensive or cyclical opportunities at the appropriate juncture.
“Such pragmatism has been adopted to ensure that fund performance is more consistent relative to its benchmark. That being said, the process is not immune to periods of more variable returns, particularly over the short term, but over more meaningful timeframes the manager has delivered a compelling set of returns.”
Rolling five-year information ratios of Marlborough Special Situations and IA UK Smaller Companies sector
Source: FE Analytics
The final fund to have achieved a consistently ‘outstanding’ information ratio is Marlborough Special Situations; it scored 1.08 in this research. Run by FE Alpha Manager Giles Hargreave and Eustace Santa Barbara, the fund has made a 2,958.33 per cent total return since Hargreave took over the fund in July 1998 – the best performance of the peer group.
Hargreave puts risk management at the centre of his process, running a highly diversified portfolio (it currently has around 180 holdings) and preferring to hold high-quality businesses over the long term.
FE Invest said: “Risk management is taken seriously and the managers show discipline when they sell stocks that have been doing well and avoid becoming too invested in positions, asking whether they would buy their current holdings now or if there are better options out there.”