Interactive Investor

Fund Awards 2014: UK Smaller Companies

17th June 2014 16:01

Helen Pridham from interactive investor

Larger fund winner: River & Mercantile UK Equity Smaller Companies

Shares in UK smaller companies have had a good run over the past couple of years and all sector funds have benefited. So it has required something special to win one of our awards, especially given the inherently higher risk involved in backing smaller businesses. 

The manager of our winning fund, Daniel Hanbury, is celebrating two trophies this year. He was highly commended in the UK growth category with another fund he manages.

He uses a common investment approach for both: "At the heart of the investment process is our proprietary stock screening system, MoneyPenny, which scores and ranks stocks on our PVT criteria." The PVT criteria are matched when stocks with strong potential (P) for shareholder value creation that are undervalued (V) can be bought at a supportive time (T).

However, in reality, he feels lots of factors have contributed to the fund's consistent performance over the past three years.

He says it has been especially helpful not to be pigeonholed in terms of style, as this has allowed him to buy different types of company. He prefers to blend investments from various areas to optimise his portfolio.

He believes outperforming the stock market is always challenging. However, he says: "It is easier at the small-cap end of the market and the outlook for smaller companies continues to be favourable. Smaller firms have, on average, a greater opportunity to grow from small market shares than their larger brethren."

The River & Mercantile UK Equity Smaller Companies fund returned 106.9% in the three years to 1 March, compared with an average of 64.6% for the UK smaller companies sector. In the past year its ongoing charges figure was 1.7%.

Smaller fund winner: AXA Framlington UK Smaller Companies

Being a smaller fund that invests in smaller companies can be a distinct advantage, as it enables the fund's manager to take meaningful stakes in companies without becoming too dominant on their share registers. However, it may not take long for the winner of our small UK smaller-companies fund to grow into a larger fund if it continues to achieve consistent performance.

Henry Lowson, manager of the AXA Framlington UK Smaller Companies fund for the past two years, says he basically follows the so-called "growth at a reasonable price" approach. This means not overpaying for companies he believes offer sustainable, superior earnings growth. He says: "This has been quite difficult over the past two years, because markets have had a value rather than a growth tilt."

He believes the fund's success has come from buying smaller companies that were ignored by many investors after the financial crisis because they were too small. "We particularly like buying into companies where not all the good news has been priced in," he adds.

Another valuable attribute he looks for in a company is "optionality" which he describes as "optionable upside to a company's earnings going forward". He cites Scottish television company STV, in which he has a stake, as one such business. STV managed to negotiate better terms with ITV, which improved its cash flow and enabled it to pay off more of its debt.

However, he says choosing investments normally involves a three-stage process. First, he looks at overall themes and at areas that may benefit from economic tailwinds. Then he considers companies where there are barriers to entry. Finally, a view is taken on a company's valuation.

Typically, about a third of the fund is invested in companies in the FTSE SmallCap index, a third in AIM stocks and a third in FTSE 250 stocks. He explains: "I don't normally buy stocks that are in the 250 index, but I am not a forced seller when they move into this league. Recently, it is at the lower end of the FTSE SmallCap that we have found the best deals."

The fund returned 81% in the three years to 1 March, compared with an average of 64.6% for the UK smaller companies sector. In the past year its ongoing charges figure was 1.6%.