Not everyone in the offshore UK small-cap sector is a stockpicker, as the Scudder Threadneedle process demonstrates
Although there are relatively few funds in the offshore universe with a three-year track record investing in UK small caps, the number may increase in line with growing recognition of the asset class.
One of the better-performing funds over one year is Eagle Star UK Smaller Companies, run by a team headed by Paul Cramp of Scudder Threadneedle Investments, who, until May 1999, ran UK small caps at Rothschilds.
Although it does not have a three-year track record under its present manager, the fund is up 2.71% over one year to the start of June 2001 and up 17.87% from June 1999 to May 2000.
Cramp was brought in by Threadneedle to bring a robustness of process and commonality of return across the group's UK small-cap mandates
Part of this was moving the benchmark from the FTSE Small Cap index to the Hoare Govett, which involved a fairly large shift in the £1.5bn of UK small-cap mandates run by Scudder.
The process Cramp has instituted is unusual in the small-cap arena in that it is top-down focused. 'Many people have the idea that the best way to invest in small caps is to work purely on a bottom-up basis: to meet a company, think it has good growth prospects and buy in,' Cramp said. 'However, I have never worked in that way.'
Cramp's investment process begins with a top-down economic expansion model, which aims to pick up on themes in the UK economy.
Via this model, he is able to shape and tilt the portfolio toward growing areas of the economy, with the themes that emerge followed decisively.
'This type of analysis is especially relevant to small-cap investing because these companies are particularly geared to the domestic economy, whereas larger companies tend to be more international,' he said.
Key themes over the past year have included government infrastructure spending. This focuses on companies positioned to profit from the private finance initiative idea, involving the building of hospitals, roads, prisons and schools.
'We do not try to be too clever, in terms of attempting to pick the single company that will be the best performer,' Cramp said. 'If we believe in the efficacy of the economic expansion model then the whole sector should go up, in any case.
'We tend to buy a number of companies and then wean out the ones we want as they develop.'
The fund has also been skewed toward retailers in line with Cramp's belief that the UK consumer should remain fairly robust.
It is also playing the wealth management theme via holdings such as Brewin Dolphin and Singer & Friedlander.
One of the most prominent and fast-growing themes in the portfolio is power generation. Although the small-cap mandate precludes the buying of power generators, the fund is invested via companies with exposure to higher capital expenditure as a result of the robust oil price and shortage of power worldwide.
Having generated the model and identified themes, Cramp and his team turn their attention to building the portfolio from the bottom up.
From an initial universe of around 2,500 companies, a size screen eliminates those too small to be potential investments, slimming the universe down to around 650 companies whose P/E to growth ratios are then scrutinised using consensus forecasts looking two years forward.
Cramp said: 'Clearly, the PEG number can vary depending on the type of business. For example, an engineering company with a PEG of around one would probably be most appropriate.
'For a more exciting outsourcing type play, a PEG of two or three might be appropriate. The important thing is that we must always be able to see the number turning to normal over a certain time horizon.'
From a universe narrowed down to 350 companies, Cramp then builds a portfolio of around 80 holdings. In the current volatile markets, he believes the key area of focus is P/E expansion and contraction rather than earnings growth.
Best performing of all funds with a three-year record is the Singer & Friedlander AIM fund, up 68.02% over three years. This breaks down as -2.58% over one year, 80.07% from June 1999 to May 2000 and -4.22% from June 1998 to May 1999.
The fund is run by Richard Hallett in a highly aggressive, stock-specific fashion. He also employs a macro and thematic backdrop to guide stock selection.
As can be seen from the scatter plots above, it has the highest annualised alpha and beta in its sector, along with the highest return and risk levels.
Hallett focuses particularly on companies offering 'best of breed' products in niche counter-cyclical growth markets, aiming to look two or three years ahead.
He particularly examines management, who must have a track record in delivering shareholder value, and then products, which must be in an area which has significant barriers to entry.
The number of UK smaller caps funds may be set to increase in line with growing recognition of this asset class.
Eagle Star UK Smaller Companies is one of the sector's best performing funds
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