Fund Awards 2013: UK Growth

Best larger fund: Cazenove UK Opportunities

A core holding for most UK investors is a fund invested in companies listed on the UK stockmarket.

Buying shares in UK-listed companies means investors are not taking any currency risks. It also means the investment manager should have access to plenty of local knowledge about them.

To find out how the winners are chosen, read:Money Observer Fund Awards 2013: Quantitative methodology.

Our winning fund in this very competitive category is Cazenove UK Opportunities, which is managed by Julie Dean. She certainly needs to know a lot about the companies she invests in as she has to identify whether they fit into her business-cycle approach. She describes this as "taking a pragmatic approach to identifying [investment] opportunities in the UK throughout the cycle".

The fund's aim is to outperform the FTSE All-Share index by 3% a year over the medium term. It has grown to more than £1.2 billion and can invest in companies of any size. The portfolio is quite concentrated and tends to hold between 35 and 65 companies.

Explaining how she achieved consistent performance over the past three years, Dean says that being overweight in support services, media and industrial engineering sectors all contributed. Avoiding two sectors - mining and oil and gas - also helped. At the stock level, top contributors were companies such as Howden Joinery, Melrose Industries, Elementis and Babcock International Group.

To put her investment approach to good effect, Dean has to take a strong view on what the economy is doing and then look for companies that will perform in that environment. Her stock selection is driven by thorough analysis of changes in earnings relative to the business cycle. She explains: "Flexibility is key - I'm not bound by sector or style bias. This means I can switch between cyclical and defensive stocks as the business cycle progresses."

Looking to the future, Dean says there are still a number of risks to a smooth economic recovery. "It seems unlikely that markets will stop worrying about growth in 2013," she says. "However, leading economic indicators continue to improve and a better-than-expected growth outcome is possible - so we will retain our pro-cyclical shape a while longer. We will continue to use business-cycle analysis as a guide to stock selection, seeking to shift clients' capital away from bad risk and towards good risk as the business cycle progresses."

Highly commended larger fund: Liontrust Special Situations

There are more than 250 funds in the UK all companies sector from which our award winners are selected. Some are relatively general while others focus on particular types of companies.

In the case of our highly commended fund in this category, Liontrust Special Situations, it features a relatively concentrated portfolio of currently less than 50 holdings and it tends to favour smaller companies. The fund weighs in at £650 million.

Liontrust has won previous Money Observer awards for its UK equity funds and its smaller companies fund is one of this year's winners. Both funds are managed by Anthony Cross and Julian Fosh, who use an investment process they call "economic advantage" to spot companies they believe are under-appreciated by the market and have strong share-price growth potential.

The managers explain: "We are prepared to allow value to emerge over time, and stick with companies through downturns, provided that their business fundamentals remain intact."

One such company is Wilmington Group, a provider of training and trade publications primarily for the legal, insurance and healthcare sectors. Cross and Fosh point out: "Its shares were de-rated in 2011 mainly due to tough cyclical conditions in the legal market. Its growth has been hampered by the UK recession, and in May 2011 it issued a warning of weaker demand, particularly in its legal training business.

"The company is cash-generative and was able to maintain a high dividend level through the downturn, and we topped up our investment in its shares despite the indication that it faced short-term challenges. Trading conditions for the company have since improved - and its shares have reflected this."

Another holding that has helped the fund's performance is Smart Metering Systems, which was added to the portfolio in mid-2011. Its share-price appreciation has reflected a fairly steady recognition of the business characteristics that attracted Cross and Fosh to the investment.

Best smaller fund: Unicorn Outstanding British Companies

Like our larger fund winner in this category, our winner of the best smaller fund award in the UK Growth category is an all-rounder, investing in UK companies of all sizes. For this reason, it pipped the recipient of the highly commended award at the post. This is somewhat ironic as the company behind the fund, Unicorn Asset Management, is normally best known for its emphasis on investing in smaller UK companies.

However, with this particular fund, its main criterion is quality rather than size. Unicorn Outstanding British Companies has around £17 million in assets and is managed jointly by Chris Hutchinson and John McClure, founder of Unicorn Asset Management. They define the best companies as those that maximise shareholder value.

They also believe the companies that achieve long-term business success are those most likely to be successful long-term investments. In order to boil down their investment universe to a manageable size they use quantitative and qualitative screening techniques; they then carry out significant due diligence on investee companies prior to reaching an investment decision.

They list 10 criteria that companies must meet to qualify for inclusion in the fund. These include factors such as businesses being understandable and having predictable earnings and cash flow. In essence they seek to identify established, profitable, cash-generative businesses capable of generating significant growth over the longer term.

These businesses can include large UK companies such as, currently, Rolls-Royce and British American Tobacco, as well as companies listed on the Alternative Investment Market. It is intended that approximately 75% of the fund will be invested in established companies, and 25% in smaller, faster-growing companies.

The managers say they regard Unicorn Outstanding British Companies as "a distillation of everything that Unicorn Asset Management stands for in that it is highly selective, and applies a rigid set of challenging investment criteria to all new investments".

They continue: "It is a particularly high-conviction portfolio, currently 23 holdings, with a focus on long-term investment holding periods. As a result it experiences ultra-low levels of portfolio turnover. In circumstances where investment decisions do not work out as we had hoped, we effectively employ a zero-tolerance policy and such holdings are sold."

Highly commended smaller fund: Neptune UK Mid Cap

Medium-sized companies can provide rich returns. Neptune UK Mid Cap, as its name suggests, is a fund that specialises in these companies.

It has had a strong three years and its overall performance was actually somewhat higher than the winning smaller fund, but due to its more restricted remit it was awarded the no-less-worthy honour of highly commended status.

Its investment universe is the companies of the FTSE 250 index and in the 50 largest companies by market capitalisation listed in the FTSE Small Cap index, excluding investment trusts.

Neptune feels medium-sized companies are under-analysed yet they offer many investment opportunities. Mark Martin, the fund manager, explains that UK mid-caps often focus on niche areas of growth with relatively little competition and high barriers to entry. They have also outperformed the FTSE All-Share consistently over almost all timeframes.

Martin says the structure of the £86 million fund is important for its consistent performance. He explains: "I invest in three silos: recovery, structural growth and turnaround.

"I have at least 20% of the fund invested in each of these three silos. This helps to ensure adequate diversification and assists risk management. It should also assist with cross-cycle performance, which is important to me.

"I also look to marry Neptune's top-down global sector process with a strong focus on fundamental company analysis and valuation.

"By investing in businesses with good growth prospects at a cheap valuation, I find companies with a skewed risk/reward profile. In particular I focus on self-financing, highly cash-generative companies."