InvestmentsApr 13 2015

Fund Review: River and Mercantile UK Equity Smaller Companies fund

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Philip Rodrigs took over as manager of this £467.9m fund in September 2014, from Dan Hanbury, who remains at River and Mercantile.

Mr Rodrigs believes it was “a smooth transition”, given the similarity of their investment philosophies.

The fund’s objective is capital growth, which is achieved by investing in equities that reside in the bottom 10 per cent of the UK stock market by market capitalisation.

The investment philosophy behind River and Mercantile’s UK funds, including this offering, is referred to as PVT, or potential, valuation and timing.

“We’re trying to find the potential in a stock to create shareholder value,” Mr Rodrigs explains. “Does it have a valuation anomaly? Do we believe it is at the wrong price? Then timing clearly helps us with the execution of entry or exit of the stock.”

The asset manager has developed its own screening tool, nicknamed Moneypenny, to scan the market for stocks with those characteristics of potential, valuation and timing.

As far as potential is concerned, the manager is looking for four types of stock: growth, quality, recovery and asset-backed. Recovery stocks are defined as those that may have fallen out of favour or where there has been a change in management, while asset-backed stocks are those where the value of the assets is greater than the share price.

“We’re looking at stocks that are scoring at the top of those screens in the four buckets,” says Mr Rodrigs. “If a stock is scoring well and continues to do so, that’s when it would be an alert for the fund manager or the analyst to look at it and do normal verification work.”

Screening is followed by fundamental analysis. The manager is also keen on meeting the management of companies.

Turning to his positioning in the fund last year, Mr Rodrigs observes: “During 2014 the portfolio was tilted to quite a defensive approach and had quite a low beta, so that served us very well during the summer into autumn. Towards the end of the year, entering this year, [it has] been [about] finding better value in more cyclically exposed businesses. The biggest change has been the increased exposure towards Europe.”

The key investor information document for the clean B-share class shows the fund is placed at level five on a risk-reward spectrum (seven being the highest risk and highest reward), with ongoing charges of 0.95 per cent.

The fund has outperformed both its peer group, the Investment Association UK Smaller Companies sector, and its benchmark, the Numis NSCI ex Investment Companies index, by some way over three and five years. The fund produced a particularly impressive 108.48 per cent return over three years to March 31, according to FE Analytics, compared with a sector average of 50.26 per cent and a 56.18 per cent gain for the index. In the past 12 months, it generated a 1.83 per cent return for investors, against a rise of 0.23 per cent by the index and the sector’s average loss of 2.38 per cent.

“On average over the last year, the performance has been enhanced by taking a cautious approach, with that tilt towards defensive names,” Mr Rodrigs explains. “There was an appetite for more defensive, telecom-related companies. Big holdings in Redcentric, Gamma and Cable and Wireless helped with low betas and strong earnings growth.”

But he has been less impressed by the utilities sector in the UK. “I have been disappointed with how the market has been valuing suppliers to the utilities space. I am thinking of companies that have helped their customers switch to better-value deals. There seems to be a misconception that just because the price of energy is falling that any energy company or any company that services the sector should necessarily have a weaker time.”

Finally, Mr Rodrigs is enthused by the outlook for UK smaller companies this year in spite of the uncertainty in the market brought on by the impending general election and is buying into value opportunities he sees in the sector.

EXPERT VIEW

Ken Rayner, investment director, Rayner Spencer Mills Research

The River and Mercantile team has developed a strong in-house stock-screening system with the managers able to provide an overlay utilising their own flair and talents. This fund is smaller than many in the sector, allowing it to exploit more opportunities away from mid caps – this is a genuine UK small-cap portfolio. Manager Philip Rodrigs had established a strong record in this space in his previous role at Investec and demonstrates an excellent understanding of company fundamentals. The strength of a tried-and-proven process, together with the flair of the manager, justifies the fund being used as a core holding in smaller companies.