Having shown remarkable resilience since the Brexit vote of 2016, UK smaller companies have found themselves under pressure once again this year, as thousands of them look to survive the financial implications of the imposed lockdown to tackle Covid-19.
At one point, the onset and uncertainty saw one research and accountancy firm suggest between 800,000 and 1m firms nationwide could face closure if they did not get the cash they needed from government-backed loans to survive.
The sell-off between February and March saw the average fund in the Investment Association UK smaller companies sector fall by almost 40 per cent, only to bounce back by 35 per cent since then in what has been a rollercoaster ride for all involved.
But history suggests you ignore smaller companies at your peril. The Numis Smaller Companies 1000 index has returned almost double that of the FTSE All Share in the past decade alone (140 per cent compared with 77 per cent).
Experience is the key and that is what this week’s best in class brings. The LF Tellworth UK Smaller Companies fund launched in November 2018 and is run by two highly regarded managers in Paul Marriage and John Warren.
The managers had an outstanding long-term track record on their previous fund, Schroder UK Dynamic Smaller Companies, where Paul delivered twice the return of the average IA UK Smaller Companies fund manager.
Mr Marriage ran the fund from 2006, with Mr Warren joining as co-manager in 2010. Both left in 2017 to set up Tellworth, where they are majority shareholders.
This fund is the flagship of the business - a true smaller companies fund with around 75 per cent typically held in businesses with £100m to £500m market cap. It does not invest in micro-caps or mid-caps like some peers and the managers begin with a series of screens to refine their investment universe.
They start by eliminating high risk speculative stocks and do not invest in ‘blue sky’ companies, oil & gas, biotech or mining firms. The remaining 600 stocks are then put through a series of screens.
The ‘Sinners’ screen excludes stocks with aggressive accounting, poor corporate governance or a weak financial position.
The ‘Alpha Seeker’ screen looks for companies that are poorly covered and have the most potential to be mispriced.
Finally, the ‘Thermostat’ screen looks at the short term (3-6 month) conditions in the UK economy.
This leaves the two managers with approximately 300 stocks, to which they apply their 'PMMM' process: Product, whereby the company must have a differentiated product, backed by its own research & development; Market, in that it should be a market leader in its chosen niche; Margin - it must demonstrate the ability to grow margins and generate cash; and Management – the company’s leaders must be aligned to shareholders.
The investment approach is designed to identify not only quality businesses, but also some challenging businesses with potential for recovery. The split will depend on different market conditions and the managers can invest outside of the approach. Meeting companies is also a key part of the process.