The team tries to control portfolio risk so that they can generate an information ratio of above one, while the investment process is entirely bottom up.
“We believe that the inefficiencies in European markets, and in most markets, are at their most prevalent at the smaller companies’ level,” says Mr Ormiston. There are far fewer analysts covering smaller companies than larger companies in Europe, for example.
“Small companies should be all about growth and because they are small, the market is inefficient and they are less covered, you don’t have to pay too much for that growth.”
Mr Ormiston looks for ‘quality’ companies, which means those with evidence of a track record from the management team and some predictability. Many small companies are poor at business planning. “We are trying to find good management teams that are going places, that will take these businesses to much higher levels and will do it in a controlled and predictable way,” he explains.
Process
Mr Ormiston says that his investment process starts with the analysis of companies. However, macroeconomic factors are important to set the risk backdrop and he has daily discussions with Stuart Thomson, Ignis’s chief economist.
Changes in the portfolio are ongoing, with the main reason for selling a stock that it has hit its price target and has no further upside or catalysts. Sales are not driven by macro considerations but by other investors discovering the fund’s stocks explains the manager. A recent sale was Novia, the owner of Magna Kitchens in the UK, which was a restructuring story that other investors became excited about.
Mr Ormiston also buys stocks that are out of fashion, whose potential or history is unacknowledged. Other purchases include small stocks that are still relatively cheap but have become slightly larger so that they pass the fund’s liquidity rules, which are not to own more than five days’ traded volume of any one stock.
Performance
The fund has outperformed its universe over one, three and five years and has also outstripped its benchmark. It benefited from being more focused on smaller stocks compared with its peer group, which are largely mid-cap funds.
In addition, the fund’s quality bias in favour of companies with good management and predictable growth was also helpful last year. For the 12 months to February 6 2014, the fund returned 32.01 per cent, compared with the IMA European Smaller Companies sector average of 18.27 per cent and the HSBC Smaller Europe (ex UK) index return of 21.06 per cent.
Mr Ormiston observes that since the financial crisis many acquisitions have been of this type of company. “We don’t set out a strategy to own takeover candidates, but last year we certainly benefited from larger companies bidding for two or three of the names we own,” he says. These included Algeta, a Norwegian cancer drug maker, which was taken over by the German drug giant Bayer. Another company, RhoenKlinikum, which operates hospitals in Germany, was taken over by a larger competitor, Fresenius. KHD Humbold, which makes cement plants, was taken over by its Chinese joint-venture partner. Mr Ormiston explained that the market had disregarded the stock but he was interested in it because the entire value of the market capital was equal to the net cash on its balance sheet.
Technology was another theme that worked well for the fund, including internet security companies Fingerprint Cards, Ingenico and Gemalto.
Looking ahead, the manager expects the continuing economic backdrop of sluggish growth to be supportive for equities and while valuations are no longer cheap they are not particularly expensive either. However, he adds: “We are trying to find stocks and companies that will deliver earnings and dividends growth irrespective of economics.”
Expert View
Darius McDermott, managing director, Chelsea Financial Services:
“This is the smallest fund of the three with roughly £50m of assets. It has been the most consistent since its launch in 2008, however, so it’s perhaps a surprise the fund hasn’t attracted more money. It currently has approximately 50 companies making it quite a diversified portfolio at this level. Unlike the other two funds, it’s not really a true small-cap fund though as it has roughly 40 per cent in mid caps too. That’s not an issue as long as investors know this is the case before investing. The manager has a large overweight to German and Irish companies and, unlike the other two funds, has quite large underweights in Switzerland, Norway and Italy.”
