InvestmentsFeb 1 2016

Fund Review: Axa Framlington UK Smaller Companies

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The manager of this £244m fund seeks to add value by finding smaller companies with scope to increase their profits sustainably.

Henry Lowson describes his investing style as “growth at an attractive price”. He says: “We’re trying to focus on those companies where not all the potential good news is reflected in the share price. [It is] where the valuations of companies can increase, or where we think analysts’ forecasts are too low and we believe the earnings could end up being a lot higher than the market expects.”

Mr Lowson insists the fund is a “genuine small cap” as it is benchmarked against the FTSE Smaller Companies ex IT index, which allows him to invest in firms with a market cap up to £600m. “Some of my peers will be Numis Smaller Companies index-focused, and the top of that index is about £1.3bn and encompasses more of the FTSE 250,” he notes.

“In terms of the process, we try to marry up three factors. We try to focus on companies where we think there are top-down sectoral thematic drivers to those businesses that we call economic tailwinds rather than headwinds. It might be new product innovation that can tackle an incumbent in a particular industry, or it might be some of the recent investments we’ve made in low-cost operators.”

The manager then takes a view on the fundamentals of a company before investing, while his third factor takes into account a firm’s valuation. “It’s easy to pick growth stocks on growth multiples; what is harder is to find stocks that can grow sustainably but probably aren’t priced as such,” he says. He currently sees value among the sub-£400m market-cap section, as he believes some of these firms are as much as 15-20 per cent undervalued.

Mr Lowson runs a fairly diversified portfolio of around 80 names. “We invest rather than trade, so we take a long-term view of these businesses and typically have a holding period of three to five years. Turnover is very low and I think that’s important when you’re investing in small and mid-cap companies,” he adds.

The manager describes himself as a “risk-averse individual” in what is typically a riskier asset class, and hence insists that no stock will account for more than 3 per cent of the portfolio. “It’s trying to get a broad base of companies all doing well, rather than having one stock that shoots the lights out and makes my year,” he explains. “On the other hand, on the inevitable occasion where I get them wrong, those stocks that don’t go right don’t ruin my year.”

Perhaps this is why the fund is placed at level five out of seven on a risk-reward scale, while the ongoing charge for the Z clean fee retail share class is 0.85 per cent.

The fund has consistently outperformed its benchmark, data from FE Analytics shows. In the five years to January 20 the vehicle generated an impressive 103.1 per cent, while the index was up 66.5 per cent and the Investment Association UK Smaller Companies sector returned an average of 57.6 per cent. Performance in the past year has held up, with the portfolio delivering 12.5 per cent against the index’s 5 per cent gain and the average sector return of 7.1 per cent.

Mr Lowson believes the fund has proved it can outperform in up and down markets.

Investing in low-cost operators has also added to performance, with the manager singling out low-cost gym network The Gym Group. He also mentions online travel agent On the Beach, which “because it has no high street presence like Thomas Cook and Tui, immediately starts off at a 20 per cent cost advantage to those players”.

The manager says holding Conviviality did well for the fund in 2015 following its acquisition of a drinks distributor, a deal he says was “40 per cent earnings enhancing”. But he sold out of retailer Bonmarché last year after the departure of its chief executive, and healthcare services provider Cambian due to wage price inflation pressures.

Mr Lowson adds: “We’re paying particular attention to balance sheets, because while they are still strong in the small-cap space, they are weaker than they were this time last year. Shareholder returns and payout ratios are quite high and so leverage has been going up.”

EXPERT VIEW

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

Henry Lowson has a mix of popular and more interesting names in his top 10. He seems attuned to both IPO and merger and acquisition activity, and this fresh approach will be attractive to discretionary fund managers that think unlisted firms will continue to float. More broadly, the manager’s experience in running a small-cap fund is relatively short and my first instinct would be to wait or take a smaller position to gauge how his approach weathers a full cycle or two. An early-cycle approach will be capacity-limited and in normalised markets will underperform when there is a flight to quality. The fund is a nice size and I would only consider it an issue once it has breached £500m.