This £682m fund was launched in February 1990 with the aim of providing “lower-risk access to a higher-risk asset class, and over time generate returns above the benchmark”, manager Jenny Jones says. Ms Jones has managed the strategy since January 2003 and it entered the Investment Adviser 100 Club for the first time this year.
The investment process has remained unchanged during Ms Jones’s tenure with the approach driven by bottom-up fundamental company analysis. She explains: “The portfolio holdings are a result of the attractive opportunities the analysts are finding. [We] cannot be blind to macro factors affecting a company’s industry, supply chain or demand for its product/service. The most obvious example is in energy, where in our view the oil price decline that began in 2014 was likely to go on for a lengthy period. As a result we pruned the companies we deemed to be the likely losers: high-cost producers and the most highly geared balance sheets.”
There have been changes to the portfolio “on the margin over the quarter”, such as at a sector level lowering the weight to producer durables or industrials, primarily due to some weakness in holdings in the air transport and environmental, maintenance and service sectors.
The team has also lowered the exposure in diversified manufacturing systems due to reducing the portfolio’s allocation to OSI Systems in the wake of a positive earnings surprise, while in healthcare the exposure to pharmaceuticals has been “modestly raised”.
“We remain underweight in pharma but are market weight in healthcare,” Ms Jones says. “Our weighting in medical equipment rose, primarily due to Cepheid receiving an acquisition offer from Pfizer, and we had been adding to the stock during the quarter.”
The manager points out that while there have been tweaks to the fund, “we have not been positioning the portfolio for the US presidential election”. She explains: “We buy stocks with a three-year view and typically do not try to adjust our exposures in anticipation of a political outcome. That said, we are underweight pharmaceuticals and biotechnology, which are expected to be disadvantaged if there is a Democratic victory in November. [But] our underweight is driven by our fundamental analysis and a paucity of attractive names, especially in biotech.”
The fund’s Z-accumulation share class sits at a risk-reward level of six out of seven, its key investor information document shows, while ongoing charges are 0.92 per cent.
In the five years to October 11 2016 the fund delivered 149 per cent in sterling terms, compared with the Russell 2000 index’s gain of 139 per cent and the IA North American Smaller Companies sector’s average return of 134 per cent, data from FE Analytics shows. For the year to date Ms Jones notes the fund performed well in the first six months but has lagged in the third quarter, with FE data showing a return of 32.1 per cent, which still outperforms both the index and peer group.
“The market environment changed during the quarter and the first-half leaders – utilities, Reits [real estate investment trusts] and consumer staples – lagged, and more economically sensitive and growth-oriented groups were the leaders,” Ms Jones says.
“This includes technology, where we lagged due to an underweight; healthcare, where our biotech underweight detracted; and producer durables, where as an example [air transport group] Allegiant Travel encountered some bumps due to competition on several of its key markets. Two other market factors created headwinds in the quarter: market cap and beta. The lowest market caps outperformed the larger within the benchmark, and our higher weighting in the larger names detracted significantly.”
However, looking ahead Ms Jones is encouraged by the fact small-cap valuations “are now below their long-term average relative to US large caps”. She adds: “We last saw this in 2003. We are not arguing that valuations are cheap, but the low interest rate environment has made higher multiples possible. A key tailwind is the housing market. Our asset class is differentially favoured by this group relative to large caps. Roughly 15 per cent of revenues in small caps are related to housing, and we expect this has the potential to be a longer-term opportunity for the fund.”
