Every now and again, a different sort of fund comes along. While not mainstream or suitable for everyone, they are interesting enough to add to some investors’ portfolios. I think this week’s fund fits into that category – the PFS Downing active management fund.
The next logical question is, what does the fund do that makes it different?
The clue is in the name. Fund manager Judith MacKenzie takes a private equity-style approach to investing in very small, listed companies, hence the words “active management” in the name. MacKenzie aims to buy big enough stakes to effect a change in the underlying company. This could be to encourage merger and acquisition activity, help management restructure or simply provide strategic advice to management.
In the micro-cap sector, there are many excellent companies. They are generally poorly researched by the analyst community and have insufficient liquidity in the shares to generate any real interest. These anomalies can create an excellent long-term buying opportunity for those willing to put time and effort into finding the best companies.
Currently, the average market capitalisation of the portfolio is only £84m and the current price/earnings multiple is less than eight. Many think the FTSE 100 is cheap on a p/e of around 10. A p/e of eight definitely puts that in the shade.
The focused portfolio of around 30 companies will be split into four segments. About 30 per cent will be invested in bigger, more liquid small companies. These might have less growth potential but MacKenzie is still targeting an annual return of 15 per cent from an investment in this pot. The next 30 per cent will be in companies with a market capitalisation of under £75m, with a target annual return of between 15 per cent and 20 per cent. A further 30 per cent is targeted at sub-£50m companies where some change is required, whether that is management change, restructuring, debt forgiveness, etc. Again, the target return is 15 per cent to 20 per cent a year for investments in this category. The final 10 per cent of the portfolio will be in special situations, where the shares will be extremely illiquid. Some major change might be required but the targeted return is much higher.
MacKenzie will look at various criteria but low p/e multiples (less than five is preferable) net cash on the balance sheet and a free cashflow yield of 10 per cent are all desirable attributes. Companies such as Accumuli, which provides software security, and Tracsis, which provides timetabling software for the rail industry, are examples of companies she likes. Another interesting company is Ludorum, founded by Rob Lawes, whom Downing has worked with on other ventures. It often works alongside shareholders it knows or management it has backed in the past. Ludorum owns Chuggington, a top-rated children’s show. Tomy has the master toy licence for it worldwide and has sold over 15 million trains.
Even with this proactive approach, shares of small and micro-cap companies can go overlooked for long periods. Therefore, patience is needed with this kind of fund. You might get lucky and make a quick buck if the Aim market shoots up, for example, as many holdings are listed there. However, as with the best private equity investments, a five-year-plus time horizon is needed.
This fund is currently very small and is a more specialist holding. It will never be a big fund, and in reality you would never want it to be but it could add some long-term spice to investors’ portfolios.
Ben Yearsley is investment manager at Hargreaves Lansdown