EquitiesFeb 1 2016

Fund Review: Marlborough Special Situations

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Run by veteran manager Giles Hargreave and Eustace Santa Barbara, the £1bn Marlborough Special Situations fund seeks to target opportunities in an under-researched area of the market.

Launched in 1995, it sits in the IA UK Smaller Companies sector, meaning at least 80 per cent of its assets are invested in the smallest 10 per cent of UK-listed equities.

Mr Santa Barbara notes: “Although the name ‘Special Situations’ may conjure images of distressed balance sheets or strategic turnarounds, in actuality we are looking for simple, high-quality equity stories with consistent management execution.”

The manager points out the focus is very much on the smaller end of the market cap spectrum, stating: “We believe this is a dynamic, under-researched and fertile ground for alpha generation. The aim of the fund is to achieve capital growth and superior risk-adjusted relative returns through the cycle. Historically, smaller companies have grown their earnings faster than larger companies, which has led to their outperformance over the long term.”

He and Mr Hargreave work with an investment team of more than a dozen people, which enables them to meet a large number of companies. Combined with the team’s own primary research, this helps identify stocks with growth potential not yet priced in by the market.

“Characteristics of an equity thesis that we favour include: a clear business strategy; a niche position with high barriers to entry; a disciplined management team; good visibility of revenue and earnings; strong cash generation; accelerating earnings growth; the ability to grow organically; the ability to reinvest surplus cash at an attractive return to enable non-organic growth [a self-funded rollout story]; and healthy balance sheets,” explains Mr Santa Barbara.

“The quality of leadership is particularly important in small caps and only in very rare circumstances would we invest without meeting the management first.”

With more than 200 stocks in all, initial positions are usually set at less than 1 per cent of the portfolio. “As a company’s management deliver on their promises, we often ‘average up’, though even our largest positions rarely exceed 2 per cent of the fund. That reduces stock-specific risk and as a result, volatility is below the average for the sector.”

The fund’s unbundled P share class sits at a medium five out of seven on the risk-reward scale, according to its key investor information document. The ongoing charge is 0.8 per cent.

Since launch, the fund’s A-accumulation share class has delivered a 2,285 per cent return to January 18 2016, compared with the IA UK Smaller Companies sector average of 589 per cent. It has also outperformed in the past five years with a return of 79.9 per cent against the sector average of 59.6 per cent, according to data from FE Analytics. There are two main reasons, says Mr Santa Barbara: “One is the superior long-term growth potential of smaller companies. The second is that we have a large and effective team, with plenty of experience.”

He notes a feature of equity markets in the past couple of years has been increasing merger and acquisition activity. In 2014, eight of the fund’s holdings were bid for, and in 2015 a further eight holdings were acquired. “Equity capital markets have also provided interesting IPO [initial public offering] opportunities,” he adds. “In 2015, we participated in selected IPOs including those of fund administrator Sanne, online holiday operator On the Beach and value-added reseller Softcat.”

While the portfolio is constructed in a “sector-agnostic manner”, the manager acknowledges that companies in the portfolio may share traits that explain why they did well in 2015. “These would include the niche nature of companies such as premium mixer producer Fever-Tree and wound care company Advanced Medical Solutions; consolidators such as plastics manufacturer RPC and veterinary group CVS; and rollout stories such as sports and fashion retailer JD Sports and cake purveyor Patisserie Valerie.”

He notes the oil and gas sector and the commodities space in general has been a detractor, but “on the positive side, we are generally underweight these sectors because it is difficult to assess the risk/reward profile of the companies”.

EXPERT VIEW

Jon Beckett, UK research lead, Association of Professional Fund Investors

The Hargreave franchise has been one of the strongest UK alpha stories and one that many other UK equity managers respect and try to emulate, underlined by an elite rating from FundCalibre. At £1bn and around 200 stocks, this fund is both diversified and has capacity (on paper). About 23 per cent of the fund is micro-cap; 26 per cent of the fund in stocks greater than £1bn market cap. Hargreave is known for his past micro-cap successes and the fund’s growing size may drive him up the capitalisation spectrum, indicated (in part) by more mainstream ideas like JD Sports, RPC and CVS alongside popular ‘special situations’ like cocktail darling Fever-Tree.