FTAdviser.com

Advertising

When Rory Hammerson agreed to take the reins of the £104.9m Swip Pan-European Smaller Companies fund, he did so on two conditions. The first was that the fund be run in accordance with Swip’s overall investment process. Prima facie, that would go without saying, if only because Swip prides itself on the uniformity and repeatability of this process. Yet the fund’s previous manager often strayed off course, which affected the fund’s performance, according to Mr Hammerson.

“At Swip, we have a repeatable investment process, and, across the board, the performance of our funds have benefited from the application of that process,” he explains. “This fund was run by an individual who did not adhere to that. When I took the fund over, one of my main conditions was that it be run within the investment process we use at Swip.”

The philosophy behind this process is essentially to invest in companies whose long-term earnings power is not reflected in their share price. Mr Hammerson works with a team of 22 analysts, where each member is both a fund manager and an analyst with sector-specific responsibilities.

This team does detailed financial analysis, with forecasts going forward five years, and employs a primary valuation of discounted cash flow. When necessary, it then overlays that valuation with relative measures of value, such as p/e ratios. Mr Hammerson bases his portfolio construction on two premises - the upside to price target and the level of analysts’ conviction in their recommendations.

In 2004, when the previous manager was in charge, the fund was languishing in the fourth quartile, returning just 14.6 per cent for the year to 31 May against a sector average of nearly 24.3 per cent. Since Mr Hammerson took over in January 2005, the fund has been either first or second quartile. For the three years to 9 June, according to Morningstar, the fund returned 88.9 per cent, a good deal better than the sector’s average return of 67.6 per cent and the index’s return of 56.8 per cent.

Mr Hammerson’s second condition for managing the fund was that its universe be widened considerably. “I am relatively unconcerned with market cap,” he explains. “I am far more concerned with the potential of alpha generation, which is why I wanted to widen the mandate and why the fund is called ‘smaller’ companies rather than ‘small’ companies.”

Consequently, the bottom of the fund’s market-cap range was lowered to €100m, while the top of the range was lifted to €8bn (£6.3bn). Over the last three years, this has been particularly helpful, as Mr Hammerson has found far more value among mid caps than micro caps, he says.

The fund is 100 per cent bottom up, and approximately 90 per cent of its risk budget, as measured by tracking error, comes from stock-specific risk, as opposed to sector, country, currency or style risk.

“We don’t control risk, per se, but we look at the risks that are a consequence of the portfolio construction,” Mr Hammerson says. “The only risk control that would alter the way I construct the portfolio is if the fund moved into the upper quartile of its tracking-error range. Otherwise, we are completely stock-specific and bottom up.”

Three companies identified by this process include Fugro, Lonmin and Grifols. The first, a geological engineering company based in the Netherlands, is the largest holding, accounting for 3.1 per cent of the portfolio. Mr Hammerson has held the stock for about three years now, and it is still trading very much below its intrinsic value, he says. “Quality of management,” he adds, “is absolutely fundamental, and we have been very impressed with the management.”

The second, also accounting for 3.1 per cent of the portfolio, is a London-listed platinum miner. Not only is the company undervalued, but demand for platinum continues to outstrip supply, and production volumes have become increasingly difficult to maintain due to geological conditions and a complicated refining process. This, combined with strong metal prices, means Lonmin’s potential to grow its volumes over time is "very, very interesting.”

The third, accounting for 3 per cent of the portfolio, is a Spain-based producer of plasma derivatives. A small company in which Mr Hammerson has been invested since it was listed, Grifols breaks down blood into its components, which can then be used for various clinical purposes. It is one of only three companies in the world that do this sort of work, and it is the only one that has spare capacity, due to a technological advantage.

Mr Hammerson says he is confident he will continue to find similar undervalued small and mid-cap companies, despite the precarious markets in Europe at the moment.

“Over the last 19 years, 12 have seen positive returns for small-cap companies, so that’s a positive hit rate of 63 per cent,” he says. “And looking at the risk reward, the average positive return over that period is about 24 per cent, versus a loss of 11 per cent during an average negative year - so the positive return has been double the negative. Given that we find so many interesting valuation anomalies among small and mid-cap companies, I am fairly sanguine. This is a stock-picker’s market.”