Small cap funds win recognition
11th June 2012 14:38
by Helen Pridham from interactive investor
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Investment in smaller companies can be exceptionally rewarding. Not only do they tend to grow faster than larger businesses, they are often less well researched by professional investment analysts, so they are more likely to be undervalued.
That can lead to larger share price increases once their potential is recognised.
This year there are three main contenders for the Money Observer Fund Award winner in this category. The top performer, CF Amati, came in below our initial size requirement, while second-placed Marlborough UK Micro Cap is deemed too specialist for the main award but gets a highly commended honour instead.
The award-winner's crown goes to its stablemate, Marborough Special Situations, instead. Last year's winner, Investec UK Smaller Companies fund, was not too far behind in fifth position.
Giles Hargreave, manager of Marlborough Special Situations, explains his winning formula: "We aim for consistency and low volatility by having a much broader portfolio than other funds in our peer group. We generally hold around 260 companies, and none of these holdings represent more than 2% of the portfolio. Because it is so well diversified, we don't get sharp movements in values."
Hargreave says he is often asked how he can manage to keep track of so many companies. His answer is that he has a larger investment team working with him than most other managers. "There are about 12 of us," he says. "I make the decisions about which holdings to buy and sell, but the others are all contributing ideas."
Another factor underpinning the fund's success is Hargreave's style of investment. "We like to meet the companies we invest in, but we will normally only commit a modest amount to begin with and build up our holding as we gain confidence," he explains. "Because we do this gradually, on the back of consistent performance, we rarely have disasters among our larger holdings. Good management normally remains good management."
Around two-thirds of the portfolio is invested in small companies quoted on the AIM or in the FTSE Fledgling or Small Cap indices, while around a quarter is invested in medium-sized companies. Hargreave says medium-sized firms have been added to the portfolio as the size of the fund has grown.
His aim is to hold companies that can survive, even in poor economic conditions. While UK banks have been criticised recently for withholding finance from small and medium-sized businesses, Hargreave says the companies he has invested in have not been affected. "In our experience, those businesses that have required finance have not had a problem. But generally the companies we invest in don't have debt and have good cashflows that they can reinvest."
Hargreave admits there is still plenty to worry about regarding the future of the global economy. But he adds: "All investors should have small company funds in their portfolios, because, historically, smaller companies have done consistently better than larger companies."
Highly commended: Minor miracles win recognition
Two funds have been highly commended in this category for 2012, namely Marlborough UK Micro Cap and Cazenove UK Smaller Companies fund.
Marlborough UK Micro Cap has won this accolade for the second consecutive year. Its three-year performance actually exceeds that of its winning stablemate. However, as it concentrates on the smallest, most high-risk companies, it has been deemed too specialist for the main award.
Hargreave also manages Marlbough UK Micro Cap and he generally runs it in the same way as the Special Situations fund. The main difference is that the investment universe of the Micro Cap fund is companies with capitalisations below £100 million at the time of purchase. Indeed many had capitalisations of under £50 million when Hargreave made his first investment.
Like the Special Situations fund, the portfolio is widely diversified and contains more than 200 holdings to minimise risk.
Nearly 30% of the fund is currently invested in technology stocks, which Hargreave puts down to the many good ideas coming out of the sector. Five of the fund's largest holdings are technology companies, including , and .
However, the portfolio's diversity is underlined by one of its latest acquisitions, , an emerald miner in Zambia.
The other highly commended fund this year is Cazenove UK Smaller Companies, managed by Paul Marriage since 2006. The fund's aim is to outperform the FTSE UK Small Cap index by 3% a year over the long term.
Marriage strongly believes in visiting the companies he invests in. He and his co-manager, James Warren, are regularly out of the office scouting the UK for prospective investments and visiting companies they already invest in.
Because information about smaller companies is limited, they feel first-hand research and talking to company management is vital.
This is the reason they do not consider businesses operating outside the UK, such as oil and gas companies as well as mining companies. Only around 50 companies make it into the portfolio.
Marriage constructs the portfolio around a core of investments in smaller companies that he believes exhibit specific qualities that help generate long-term outperformance.
He uses a set of criteria that he calls P3M (product, market, margin and management) to select these companies.
He aims to invest 75% of the portfolio in these types of shares and the remaining 25% in other situations where he feels real value is exhibited.
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