Best in Class: MI Chelverton UK Equity Growth

With lockdown measures easing and the world finding its ‘new normal’, the role of active management is going to be more important than ever in the next few months.

The unprecedented impact of Covid-19 has meant no industry has been immune and the long-term impact could be immense. Regardless of whether it is restaurant, hotels, technology or airlines, consolidation will be inevitable.

The task facing active managers is to separate the winners from the losers – benchmark huggers beware.

It is an even bigger challenge for those in the mid and small-cap market, where concerns over balance sheet strength are clear.

A truly active fund which completely ignores any benchmark index, it has lived up to expectations

We only have to look back to the last bear market to see how liquidity challenges can hit these businesses. A poll by the Federation of Small Businesses at the time found that as many as 50 smaller firms were closing every day during the credit crunch.

However, given the under-researched nature of these companies, it means those managers who can spot resilient businesses can produce major returns. This week’s Best in Class fund fits perfectly into that category.

When the MI Chelverton UK Equity Growth fund launched in 2014, we felt it was one of the most exciting UK funds to come to market in recent years.

A truly active fund which completely ignores any benchmark index, it has lived up to expectations: since launch it has been the best performer in its sector of more than 220 peers, returning 140.8 per cent, compared with just 30.9 per cent for the average IA UK All Companies fund.

Founded in 1998, Chelverton is a small boutique asset manager that specialises in small and medium-sized UK companies. Its philosophy is to focus on doing a few things extremely well.

The fund is managed by James Baker, who has over 30 years of equity market experience, specialising in UK small and medium-sized firms.

Prior to joining Chelverton, he worked as an assistant fund manager at Rathbones. James is supported by Edward Booth who joined the team in 2016, becoming co-manager in 2017.

The fund invests in growing cash-generative businesses.

The process begins with a quantitative screen for revenue growth, cash conversion, balance sheet strength, high gross margins and the ability for companies to fund themselves.

Stocks must meet four out of the five requirements to pass the screen. This leaves the managers with about 150 companies for further analysis.

The second part of the process involves a qualitative assessment. James and Ed particularly look for predictability of sales, sustainability of margins, and good management.

The third step is valuation. There are two key valuation metrics. Firstly, EV/Sales (this compares the enterprise value of a company to its annual sales) in relation to maintainable margins.

This is a particularly useful measure for valuing businesses through the economic cycle.

Secondly, EV/NOPAT (net operating profit after tax) in relation to anticipated growth. Shares are sold if the fundamentals of the business deteriorate or if valuations become too high.

The portfolio typically has around 100 holdings and all investments are outside the FTSE 100. Around 25 per cent of the portfolio is in mid-caps, with the majority in the UK small-cap space.

The fund currently has a third of its underlying holdings in technology (19.2 per cent) and healthcare stocks (12.7 per cent).

Its largest holding is Clinigen (2.1 per cent), which looks to provide ethical, regulatory compliant and efficient solutions to help pharmaceutical and biotech companies provide access to medicines – a growing industry pre and post Covid-19.

Not only is there a clear investment process, but quantitative screens are well-thought out with the team looking to gain a far better guide of the company beyond the bald statistics; by also understanding what makes them ‘tick’.

The fund’s performance is proof at how adept they have been at doing precisely that.

Darius McDermott is managing director of FundCalibre