UK small caps are one area where the team behind Waverton’s model portfolio service are happy to take on active fees in return for more alpha.
While the team is willing to use passives where appropriate, John Bellamy, head of the model portfolio service, said there are some sectors that lend themselves better to an active approach.
“Historically we have used trackers to tactically manoeuvre the portfolio,” he said.
“We are neutral on the UK but we think within the UK there are some good opportunities, particularly when you come to look at some of the active funds that we use.
“We do like some of the active managers down the [market] cap scale within the UK as I think we can find some genuine alpha there and are quite happy to hold those on a long-term basis.”
Indeed, as the below shows, the average fund in the IA UK Smaller Companies sector has outperformed the Numis Smaller Companies ex IT index by 14.22 percentage points over five years.
Performance of sector vs benchmark over 5yrs
Source: FE Analytics
In the sector, Waverton uses two managers, one that is available to retail investors and one that is not – but that investors can gain access to through their service.
The first is the £95m MI Chelverton UK Equity Growth fund, which actually sits in the IA UK All Companies sector but has a strong smaller companies bias.
The fund has just a 13.7 per cent weighting to companies with a market capitalisation above £1bn, with 58.3 per cent in stocks worth less than £500m. It also has 7.3 per cent in cash.
“That has been a great holding for us and it also gives us exposure to technology which is an area of the market where we want to increase exposure,” portfolio manager Luke Hyde-Smith said.
“If you are going to get exposure to tech within the UK market you have got to go down the cap scale.”
Indeed, the fund has a 27 per cent weighting to technology companies with 17.3 per cent in consumer firms and 15.7 per cent in industrials.
MI Chelverton UK Equity Growth is run by David Taylor and James Baker who the manager said is a particularly strong draw for investors.
“[Baker] is a very experienced stockpicker and while admittedly he hasn’t had a huge experience of running a fund, he has 35 years as a sell-side analyst and is extremely highly regarded across the board,” he said.
“If you talk to any UK smaller companies manager they’ll know James Baker because he provided [them] with their best ideas. He has decided to do it himself at Chelverton and it has been a huge success,” Hyde-Smith added.
The fund was launched in 2014, during which time it has returned 93 per cent, compared to a 47.7 per cent return for the Numis Smaller Companies ex IT index and the 34.01 payout from the IA UK All Companies sector.
Performance of fund vs sector and Numis Smaller Companies ex IT index since launch
Source: FE Analytics
This is the best return in the sector over the period and would place it as the second best performing fund in the IA UK Smaller Companies sector since its inception.
“This would be an example of a fund that we are happy to back reasonably early in its life,” Hyde-Smith said. “We like that because we are backing a fund when it is generating its track record rather than living off it.”
“Obviously, with the UK smaller companies one of the big things is how to position and liquidity and we want to be in a fund that has the ability not only to buy a sufficient stake in companies they like but to sell at the right time.
“While there are a lot of well-known and good smaller companies managers what you’ll find is that the majority of them run a lot of money and that is definitely a hindrance for that particular market.”
The fund has a yield of 1.02 per cent and a clean ongoing charges figure (OCF) of 1 per cent.
The other fund that the Waverton team has pinpointed in the UK smaller companies space is the £29m MontLake Tosca Micro Cap Ucits.
This is a slightly more specialist fund, Hyde-Smith noted, that would only be able to be held in a model portfolio and is not available on platforms.
The fund runs a value-orientated strategy with a focus on the UK micro-cap section of the market and invests in companies with a market capitalisation of no more than £250m.
“Tosca have committed to cap it’s [assets under management] at £50m and to ensure that 10 per cent of the fund is partly capital so we feel there is a clear alignment of interests between us as investors and our clients and the managers running the fund,” the manager said.
“They are 100 per cent focused on return generation and are trying to return 15 per cent per annum net of fees.”
Since inception in 2010, the fund run by Matthew Siebert, Daniel Cane and Jamie Taylor has returned 80.23 per cent, beating its benchmark by 63.91 percentage points.
Performance of fund vs sector since launch
Source: FE Analytics
Hyde-Smith said: “UK micro caps are obviously a very specialist area and these guys have experience in IPOs and the secondary market which is a key driver of how you can generate your returns there.
“We like it for the long-term but it is 2 per cent within our tactical allocation so we are not betting the house on it. We think it is sufficiently specialist in a fascinating part of the market to be involved in.”
The fund is made up of 43 holdings and has a high weighting to technology as well as travel & leisure and healthcare stocks, with Quixant, Rhythmone and IMImobile its top three positions outside of cash, which is currently at 15 per cent.
The fund has an OCF of 2.84 per cent.