Simon knott's discretionary unit trust is the only fund out of 71 in the sector able to produce a positive return in the year to the end of october
The UK Smaller Companies sector has had a traumatic year, with only one fund out of 71 producing a positive return to the end of October.
Only Simon Knott, manager of the Discretionary Unit Fund at Discretionary Unit Fund Managers, delivered growth over one year, with the portfolio returning 5.9% compared to the sector average decline of 21.25%.
More funds have performed strongly over three years. However, the average return is still just as low, at -21.08%, while Knott's fund posted a gain of 36.26%.
Knott puts the fund's success down to the fact he is a deep-value investor. He does not look at momentum, growth or income but instead focuses on a business's fundamental value.
He said: 'I am very risk averse. If I do not understand a business model, I will not invest in it. As such, I have not had any technology exposure over the past three years, so I have a better universe to invest in than most other fund managers in the sector.'
Knott, who has been running the fund for 12 years, invests in companies with predictable profit streams in predictable market places. Most of these companies have seen good returns, he said.
Knott runs a relatively concentrated portfolio of 50 holdings, with the top 10 making up 45% of assets and the top 20 holdings accounting for 75%.
The portfolio has a low turnover, at less than 25% per year, as he believes in investing for the long term.
When looking at companies, Knott uses a number of valuation methods but barriers to entry is an extremely important theme.
He said: 'Competition is the death nail to a company's profitability. I want to invest in much more stable positions. I am good at investing in unexciting stocks.'
Over three years, John Dodd's Artemis UK Smaller Companies fund is the top performing portfolio in the sector, returning 84.54%. While the fund has not grown over one year, it has outperformed the sector by 15.87%, returning -5.38%.
Dodd said his portfolio has benefited from certain sectoral themes, especially the decision to exit technology in January 2000, just before it collapsed in May.
A year ago, the cash generated from this was invested in oil exploration and services companies, defence stocks and specialist insurance, Dodd said, all of which have performed well.
He added: 'The style and methodology of the fund has not changed at all. It has a reasonable amount of volatility but rides with the market.'
The addition of a number of fund managers to the group has also brought a lot to Artemis' investment process, Dodd said. For example, Adrian Patterson's appointment has brought additional expertise small and mid cap investing, he said.
Dodd believes while large caps rally first after a downturn for liquidity reasons, plenty of companies in the small and mid-cap arena also benefit from the initial uplift.
Dodd has a 15% exposure to Lloyd's reinsurance companies. He said: 'They have been refinanced and have plenty of momentum behind them. As a result, they have been re-rated by the market. The momentum is likely to last at least two years, possibly four.'
Since taking over the Premier UK Smaller Companies fund from Unicorn Asset Management in July this year, Robin Boyle and David Horner from Chelverton Asset Management have made three major changes.
Over three years, the fund has returned a respectable 20.53%, while over one year, it has registered a small loss of 4.27%.
Boyle, who co-manages the fund with Horner, said Chelverton cannot accept all the responsibility for this performance as the fund was in good order when it was handed over by previous manager Peter Webb.
However, he added, when Chelverton took over the fund, it was focused on a strong bull market. Some of this focus has been taken away, he said, and, to diversify the fund more, the number of holdings has been increased from 21 to 38.
A second change made to the fund is an increase in its yield from 1% to around 4.5%. Boyle believes 1% is acceptable in a bull market but in this environment shareholders want to receive decent dividends.
Thirdly, Boyle said: 'When we took over the fund, it had a high degree of cash, around 10%. This has been moved into depressed blue-chip companies. These companies on average are yielding around 7.5%, compared to the cash in the fund, which was only yielding around 1.5%. They are just as good as cash and, if needed, can be turned into cash in seconds.'
The three alterations made to the portfolio have had some short-term impact on performance, Boyle added, but will mostly benefit the fund's unitholders over the medium term.
The fund is run on a very bottom-up stockpicking basis, looking all the time for value, according to Boyle. He searches for companies that are growing and can be bought on sensible ratings.
He said: 'We are not in a bull market at the moment and it seems you take two steps forward and 1.99 steps back. In this environment, we do not want to be aggressive. We are cautiously optimistic about the sector and the value we can find in it.'
Crispin Finn, manager of the Credit Suisse Small Companies fund, is another to have achieved three-year outperformance while underperforming over one year.
Over three years, Finn has produced growth of 6.97%, yet over one year the fund is down 8.42%. As with most funds, he said, this is the result of depressed markets because of the poor economic background, which has made investors more cautious on the price they pay for equities.
Finn added the key for the fund is to find good companies at cheap prices and invest in the areas in which there is still a flow of funds. An example of this, he said, is healthcare, for which the Government has significant spending plans to meet its manifesto commitments.
While Finn believes there is always a lag effect with smaller companies coming off a downturn, as they are more tied into the UK economy than large caps, he feels their fundamentals will improve disproportionately when the economy improves.
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