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Positive thinking

The Melchior UK opportunities fund was launched last May and has already risen by 30 per cent , ranking it second out of 327 funds in the UK all companies sector.

The fund is run by Glen Pratt who, as many of you will know, was at Fidelity for over 10 years and ran the Fidelity UK aggressive fund between 1998 and 2002.

Later he joined Newton, where he ran the Newton growth fund. It is interesting to see that Glen has now gone from being involved in big companies, which inevitably have some in-house process to a place where he can take the lead.

This new working environment seems to have positively charged Glen and what struck me when I met him a few days ago was how much he seems to have changed from those days of working with big companies. He was a man reinvigorated, excited and enthusiastic. Less than a year is too short a period to judge performance but this new working environment has so far had a great effect from an investment point of view.

Glen has tried to combine his experience at Newton and Fidelity to help him run the new fund at Melchior. He has combined Fidelity’s stockpicking style and contrarian view with Newton’s risk awareness. Given his remarkable performance so far, you might expect it has come with a huge tracking error and considerable volatility. Nothing could be further from the truth.

Indeed, the fund performs far better on days when the market goes down than the other way round. So this does not seem like what you could call a rollercoaster fund.

The fund invests in a focused list of special situations, with the underlying philosophy that a positive change in the fundamentals or a positive change in sentiment will drive the stock higher on a one to two-year time horizon.

Given the performance of the fund, you might think that it is heavily invested in small and mid caps. In fact, mid caps only account for 5 per cent of the fund, with around half in small companies and Aim.

As you might expect, these have been especially successful so far. Almost half the fund is therefore invested in large caps, which in general have underperformed the other indices recently. Glen’s universe is every stock in the UK.

He uses quant screens such as Quest and Star Mine to help him sieve through the huge amount of information and pick out businesses which look like they are on an improving trend.

When looking for a change in fundamentals, Glen looks for companies where he believes future cashflows will surprise on the upside due to a change in how the business is managed.

An example of this might be Marks & Spencer, whose earnings per share recovered from 16p to 32p after a change of management. He also looks for unrecognised growth situations, where growth potential is currently unappreciated by the market.

These tend to be small or medium-sized companies, where analyst coverage is fairly thin. In addition, he looks for positive changes in sentiment which may lead to a higher valuation.

A good example of this is BT, where the market had priced in falling cashflows almost in perpetuity but Glen’s analysis suggested this was not realistic and the upside of the stock was in excess of 25 per cent.

Glen believes that every share has a performance lifecycle. He cites Sainsbury’s as an example, whereby analyst forecasts become more conservative as long-term shareholders desert the company. They are therefore slow to see a turn-round. Contrast this with Tesco, which is owned and loved by many and trades above what Glen describes as the intrinsic value of the company.

Portfolio construction is very important in helping him reduce risk. He looks closely at the risk within each stock and at the volatility. BT, for example, is a big holding in the fund but it has low volatility.

Glen works out the expected return per unit of risk for each company and as it re-rates, he will often look at recycling the holding into new ideas. In other words, he tries to reduce risk to reflect the reduced upside of the stock. This is an excellent sell discipline, keeping volatility down and stopping him falling in love with any one stock.

In conclusion, I would strongly suggest that you have a good look at this fund. At only 105m in size, it is nice and nimble but is likely to cap at around 750m, with some kind of soft close at a little over 200m.

What I found was a fully charged fund manager and, perhaps more important, one who is likely to stay for a very long time. Glen Pratt has put a substantial amount of his own money in the fund, too, so his interests are aligned with your clients’ interests.

Mark Dampier is head of research at Hargreaves Lansdown.


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