FE Trustnet

Fund, Pension, Trust / Sector Profile / Stockpicker / What I Bought Last

FINDING ITS FEETHas the AIM index come of age?

THE WINNING TICKETSStar managers’ best stock-picks

SMALL WORLDSmall cap funds around the globe

Issue 45 / November 2018

magazine

Small-cap special

A quick look at the performance

tables over the past decade shows they are dominated by the same type of fund – those focused on small caps. However, after a bull run lasting for almost a decade, would now be

a good time to reduce exposure to these funds, or would long-term investors be better off standing by them through thick and thin? This is the question I try to answer in this month’s cover feature.

Sticking with small caps, Adam Lewis

Editor’s letter

Contents

FE Trustnet

Fund, Pension, Trust / Sector Profile / Stockpicker / What I Bought Last

FINDING ITS FEETHas the AIM index come of age?

THE WINNING TICKETSStar managers’ best stock-picks

SMALL WORLDSmall cap funds around the globe

Issue 45 / November 2018

magazine

Small-cap special

CREDITSISSUE 45

FE TRUSTNET MAGAZINE (FORMERLY INVESTAZINE) IS PUBLISHED BY THE TEAM BEHIND FE TRUSTNET IN SOHO, LONDON

WEBSITE: www.trustnet.comEMAIL: editorial@financialex-press.net

CONTACTS: Anthony LuzioEditorT: 0207 534 7652

Javier OteroArt direction & designW: www.feedingcrows.co.uk

EditorialGary Jackson Editor (FE Trustnet)T: 0207 534 7680Rob LangstonNews editorT: 0207 534 7696Jonathan JonesSenior reporterT: 0207 534 7640Mai Sardon Reporter T: 0207 534 7625

SalesRichard FletcherHead of publishing salesT: 0207 534 7662Richard CasemoreAccount managerT: 0207 534 7669

Photos supplied by iStock Cover illustration: Javier Otero

UNDER THE MICROSCOPEAnthony Luzio weighs up the pros and cons of investing in small caps at this stage of the cycle P. 2-7

ROOM FOR GROWTHScottish Mortgage Investment Trust’s Tom Slater explains what made him change his mind about Airbnb’s Brian CheskyP. 8-11

THE WINNING TICKETS Holly Black looks at star small-cap managers’ best stock-picks and the prospects they are most excited aboutP. 13-16

OPEN FOR BUSINESSHenderson Smaller Companies IT’s Neil Hermon explains why foreign companies are buying up British businessesP. 18-21

runs the rule over the market’s lower reaches in every major global region and Daniel Lanyon finds the AIM index is finally coming of age after decades in the doldrums. Meanwhile, Holly Black looks at star managers’ best stock-picks and the prospects

they are most excited about for the future.

In our regular features, John Blowers explains why market-timing is a mug’s game, Crux’s Richard Penny names three UK stocks whose growth is being underappreciated and GDIM’s Tom Sparke

reveals why he is backing Janus Henderson Asia Pacific Capital Growth.

Enjoy reading,

FINDING ITS FEETThe AIM index may finally be coming of age after decades in the doldrums, writes Daniel LanyonP. 23-27

FUND, PENSION, TRUST LF Blue Whale Growth, BH Macro and Herald Investment Trust find themselves under the spotlight this monthP. 28-33

SMALL WORLDAdam Lewis runs the rule over small-cap funds in every major global regionP. 34-39

DATA HUBCrunching the biggest trends down into figures P. 40-41

CRASH DUMMIESJohn Blowers says timing the market is a mug’s game – and advises focusing on three other variables insteadP. 42-47

SECRET SUCCESSCRUX UK Special Situations’ Richard Penny names three UK stocks whose growth is underappreciated by the marketP. 48-49

Anthony LuzioEditor

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42

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WHAT I BOUGHT LASTGDIM’s Tom Sparke says he is impressed by Janus Henderson Asia Pacific Capital Growth’s focus on downside protectionP. 50-51

FE TRUSTNET trustnet.com

[ SMALL CAPS ]

Under the microscope

Anthony Luzio weighs up the pros and cons of investing in small caps at this stage of the cycle

Y ou are likely to already be well aware that small caps tend to outperform their larger counterparts over

the long term, but this tends to come at the expense of higher volatility. So with all the signs suggesting the bull run is entering its final stages, would it be a good idea to give the sector a miss for now?

The factsFirst, the facts. In the Numis Smaller Companies Index Annual Review 2018, published at the start of the year, professors Paul Marsh, Elroy Dimson and Scott Evans of the London Business School found the Numis index has achieved a compound annual return of 15.2 per cent since it opened in 1955, 3.4 percentage points above that of the FTSE All Share.

This means £100 invested in the Numis index at launch would have been worth £720,900 by the start of 2018, compared with £109,500 if the

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The law of small and large numbers means it is easier to grow from a small base than a large one

Cover story

same amount was invested in the FTSE All Share over the same period.

So why do small caps do so well over the long term? Neil Hermon, manager of the Henderson Smaller Companies Investment Trust, says there are many reasons for this phenomenon.

“They tend to have faster organic growth, higher operating leverage, entrepreneurial management teams and are agile in the face of change,” he explains. “Also, the law of small and large numbers means it is easier to grow from a small base than a large one.”

“So if you are taking a very long-term perspective, small caps have done very well,

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PERFORMANCE OF INDICES IN 1990s

Source: FE Analytics

much better than large caps. Now ultimately that is a long-term average: you do get periods when large caps do better. Do I think that small caps can continue to outperform large caps? Yes, I do. But you have to take a long-term perspective.”

Role reversalThe only decade in which UK large caps reversed this trend was the 1990s – data from FE Analytics shows the FTSE All Share made 300.84 per cent over this period, compared with 170.93 per cent from the FTSE Small Cap ex IT index.

Cover story

FTSE All Share (300.84%) FTSE Small Cap (ex IT) (170.93%)

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However, Harry Nimmo, manager of the Standard Life UK Smaller Companies fund and investment trust, says this was the result of a set of circumstances specific to that period that is unlikely to be repeated.

“You have to go back to the 1980s and Margaret Thatcher to understand this, it was basically the deindustrialisation

of the UK,” he explains.“A lot of large-cap manufacturers sank into the small- and mid-cap market to the extent that they dominated the sector exposure by the late 1980s and early 1990s.”

“And of course, the deindustrialisation continued and the stocks continued to underperform and dragged down the whole index. That process continued into the late 1990s.”

However, it was at this point that another group of small-cap businesses began to emerge. While many speculative tech investments quickly became worthless following the bursting of the dotcom bubble, successful smaller businesses whose sales were previously confined to the UK suddenly found they had a cheap and easy method of selling their products globally.

Tastes of successNimmo notes the internet also helped to drive a convergence of consumer tastes around the world, further boosting small caps.

“If you go to Japan or China, you have all the same brands,” he says.

“I always think of names like Ted Baker and Hugo Boss in Europe: these were all small companies that have

become big because they have been successful outside the home market. That just wasn’t possible to the same extent 20 years ago.”

As Nimmo notes, the small-cap effect is not confined to the UK. Further research by Dimson, Marsh and Evans found small caps outperformed in 19 of the 21 largest countries in the FTSE World Index between 2000 and 2017, with an average annual premium of 5 percentage points.

So, why not go all out investing in this area of the market?

Of course, the price you pay for higher returns is higher risk.

The internet helped to drive a convergence of consumer tastes around the world, further boosting small caps

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Data from FE Analytics shows the maximum drawdown for the FTSE Small Cap ex IT index in the financial crisis stands at 64.78 per cent, almost 50 per cent higher than the 45.28 per cent figure for the FTSE All Share.

Flight to safetyHermon says the main reason small caps don’t do well in recessions is due to the cyclical bias of the sector, adding there is generally a flight to liquidity and the safety of large caps in an economic downturn. With the period of economic expansion in the US – which drives much of global

growth – now one of the longest in history, the consensus is a recession is due in the next few years.

So is it really a good idea to invest in small caps at this point in the cycle?

“Well, where are we in the cycle?” Hermon asks. “That is the point. The macro environment has become more challenging in the past month, but the US economy is still growing

Cover story

very quickly. And although growth is slow in the UK, it is still growing.”

Leigh Himsworth, manager of the Fidelity UK Opportunities fund, says another reason why smaller companies struggle in recessions is due to a higher gearing to the local economy, as they have had less of a chance to grow internationally.

While the FTSE 100 derives about 70 per cent of its earnings from abroad, this figure drops to just under 50 per cent for small caps. And, with the date for the UK’s exit from the EU fast approaching, there are fears a recession could strike at home long before it hits the rest of the world.

Bearing the bruntHowever, Himsworth says that while domestically focused sectors are likely to bear the brunt of any correction in the worst-case no-deal Brexit scenario, the impact will not be limited to small caps.

“For instance, FTSE 100 member Lloyds Bank is the largest provider of mortgage finance in the UK and a large player in car finance,” he adds.

“There may also be some domestic stocks that benefit from such a scenario – either those that export their goods from the UK, having just become cheaper, or those that compete with imported goods, such as some food manufacturers.”

“This makes the question more complicated. In summary, there is

little substitute for knowing your companies well and using a market setback to buy cheaper stocks that may have been indiscriminately sold off.”

“Can’t help but be worried” Nimmo says that while he “can’t help but be a bit worried about Brexit”, avoiding small caps until the storm clouds lift is a form of market timing, which is never a good idea.

He carried out his own research into how a medium-term investor would have done if they bought his fund at the worst possible moments, and was encouraged by the results.

“I mean, if you got your timing completely right, you got a 21 per cent per annum return,” he says.

“But if you invested in November 2006 so you had two years of bear market and then recovery, you still would have had returns of nearly 10 per cent per annum if you held for six years. Similarly, if you invested in December 1999, there was a three-year bear market, but you would have been bailed out in 2003 to 2006.”

“Even if you got it dead wrong, you still got a 10 per cent per annum return. And I think that is acceptable.”

So, for long-term investors with a time horizon of 10 years or more, small caps represent one of your best bets for maximising returns. This isn’t guaranteed, however; the only thing you can be sure of is there will be plenty of bumps along the way.

“There is little substitute for knowing your companies well and using a market setback to buy cheaper stocks”

PERFORMANCE OF INDICES IN FINANCIAL CRISIS

Source: FE Analytics

FTSE All Share (-34.16%) FTSE Small Cap (ex IT) (-59.88%)

[ SMALL CAPS ]

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[ BAILLIE GIFFORD ]

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Room for growth

When Tom Slater first came across Airbnb’s Brian Chesky, he didn’t spot the magic. Here the joint manager of Scottish Mortgage Investment Trust explains why he changed his mind

I was sitting behind Brian Chesky, the chief executive officer (CEO) and co-founder of Airbnb, at a conference in

Arizona in November 2011. Chesky was due to speak the following day, but he was still working on his slides, shuffling things around. I was thinking, “Who is this guy? This is a big event tomorrow, and he’s not even finished his presentation yet.”

The following day, I sat and listened to Chesky. We didn’t invest. Later, I came across an interview with Jeff Jordan, a venture capitalist at Andreessen Horowitz and former

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An ecosystem has sprung up, with individuals and companies managing over 5 million properties listed with Airbnb

Advertorial feature

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CEO of OpenTable. He was talking about listening to Chesky at that same conference, and how the penny dropped for him that Airbnb was going to be the eBay for hospitality. It was going to be massive. Jordan went out and led a round of funding that valued the company at $1.3 billion. I listened to the same presentation, but I didn’t see the magic. The penny didn’t drop for me until July 2015, when we invested. By then the company was worth 20 times as much. Often the biggest mistakes we make are not investing early enough in companies.

I’ve stayed in Airbnbs on my extended visits to San Francisco and with my wife when she ran the London Marathon earlier this year. Our Airbnb apartments were generally a little more comfortable and luxurious than the airbed accommodation originally rented out

in San Francisco when Airbnb began in 2008. Its great attraction to users then was that it was cheap.

Airbnb created a new kind of accommodation that has displaced cheaper hotels and bed and breakfasts: home rentals. At the same time, it built up an inventory of underutilised assets – rooms or second homes – and created income for the people who rented them out. Since then, an ecosystem has sprung up around it, with individuals and companies managing over 5 million

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[ BAILLIE GIFFORD ]Advertorial feature 10 / 11

For more details on the Scottish Mortgage Investment Trust, including the Key Information Document, please see our website at www.bailliegifford.com

This article does not constitute, and is not subject to the protections afforded to, independent research. Baillie Gifford and its staff may have dealt in the investments concerned. The views expressed are those of Tom Slater, are not statements of fact, and should not be considered as advice or a recommendation to buy, sell or hold a particular investment. If you are unsure whether an investment is right for you, please contact an authorised intermediary for advice. Baillie Gifford & Co Limited is authorised and regulated by the Financial Conduct Authority (FCA). The trust is listed on the London Stock Exchange and is not authorised or regulated by the Financial Conduct Authority.

properties listed with Airbnb. Today Airbnb has more bookable listings than any major hotel group and is in 81,000 cities and over 191 countries around the world.

Travel is a global market, by its very nature. And it is becoming increasingly clear that travel is a winner-takes-all market. In the future there won’t be separate online hospitality companies in every country, just one dominant global player – Airbnb.

Airbnb has created a marketplace. We like marketplaces, because they don’t require much capital to add another component.

Amazon is a classic example. It started with books and has expanded into selling multiple other product lines such as music, apparel, consumer electronics and groceries.

Marketplaces create value on both sides, in Airbnb’s case not just for travellers, but for hosts too. Marketplaces can be scaled up, because the more users you have, the more suppliers you get. The more suppliers you have, the more users want to use your service. There is a competitive dynamic highly skewed towards the largest provider. The returns on scale can be huge.

We believe that Airbnb is thinking about growth in a similar way to Amazon in its ideas about expanding the travel experience, by creating different categories of accommodation, including luxury homes and boutique hotels and unusual spaces that aren’t

Airbnb has run into some challenges with local authorities and regulators, but we have been impressed by the proactive way in which it has dealt with these

homes such as yurts, treehouses, boats and igloos. It’s offering experiences, from Beatles tours to hunting for truffles, with local guides who get an income from them. At the same time Airbnb has stayed focused and avoided expanding into lower margin and non-core areas such as flights.

By acquiring an inventory of each trip, Airbnb is at the hub of all the data, which it can use to support profiling and marketing. There are some parallels with Amazon. And underpinning both brands is the customer’s trust.

Airbnb has run into some challenges with local authorities and regulators, but we have been impressed by the proactive way in which it has dealt with these.

Chesky was very young when he started Airbnb, but he has consistently demonstrated that he can learn and grow. Anybody who goes from nothing to running a business at this scale is a unique individual. I only wish we had spotted the magic earlier.

The value of a stock market investment and any income from it can fall as well as rise and investors may not get back the amount invested. Investments with exposure to overseas securities can be affected by changing stock market conditions and currency exchange rates. The trust’s risk could be increased by its investment in unlisted investments. These assets may be more difficult to buy or sell, so changes in their prices may be greater.

*Ongoing charges as at 31.03.18. **Source: Morningstar, share price, total return as at 30.09.18. Your call may be recorded for training or monitoring purposes. Scottish Mortgage Investment Trust PLC is available through the Baillie Gifford Investment Trust Share Plan and the Investment Trust ISA, which are managed by Baillie Gifford Savings Management Limited (BGSM). BGSM is an affi liate of Baillie Gifford & Co Limited, which is the manager and secretary of Scottish Mortgage Investment Trust PLC.

SOME OPPORTUNITIES ARE MORE EXCLUSIVE THAN OTHERS.A company’s ability to exhibit exponential growth lies at the heart of the Scottish Mortgage Investment Trust, managed by Baillie Gifford.

Our portfolio consists of around 80 of what we believe are the most exciting companies in the world today. Our vision is long term and we invest with no limits on geographical or sector exposure.

Baillie Gifford’s track record as long-term, supportive shareholders makes us attractive to a new breed of capital-light businesses. And our committed approach means we can enjoy a better quality of dialogue with management teams at transformational organisations such as Alibaba, Dropbox and Airbnb. So it is a case of who you know as well as what you know. Over the last fi ve years the Scottish Mortgage Investment Trust has delivered a total return of 206.2% compared to 110.2% for the sector**.

Standardised past performance to 30 September**:

2014 2015 2016 2017 2018

Scottish Mortgage 27.6% 4.2% 37.0% 30.4% 29.0%

AIC Global Sector Average 11.2% 7.1% 24.4% 22.7% 15.1%

Past performance is not a guide to future returns.

Please remember that changing stock market conditions and currency exchange rates will affect the value of the investment in the fund and any income from it. Investors may not get back the amount invested.

The Trust’s risk could be increased by its investment in unlisted investments. These assets maybe more diffi cult to buy or sell, so changes in their prices may be greater.

For some very exclusive opportunities, call us on 0800 027 0132 or visit us at www.scottishmortgageit.com

A Key Information Document is available by contacting us.

COSTS MAKE A REAL DIFFERENCE TO PERFORMANCE – OUR ONGOING CHARGES ARE JUST 0.37%*.

SCOTTISH MORTGAGE INVESTMENT TRUST

Long-term investment partners

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The winning tickets

Holly Black takes a closer look at star small-cap managers’ best stock picks and the prospects they are most excited about for the future

12 / 13Your portfolio

S maller companies can be a notoriously tricky hunting ground for fund managers. These fledgling firms are at

an earlier stage in their development, with business models that have yet to be tested throughout the economic cycle, customers who have yet to prove their loyalty, and competition from established players yet to be staved off.

As a result, small cap stocks are more prone to failure than their larger counterparts. But investors who pick correctly in this market of under-researched businesses can be richly rewarded. These are the companies that few people have heard of but that may go on to become household names and market leaders.

GatewaysMarlborough Special Situations co-manager Eustace Santa Barbara first bought shares in hotel company PPHE in 2013 when they were priced at around £3. Santa Barbara was encouraged by the location of its hotels in so-called “gateway” cities

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[ WINNERS ]14 / 15Your portfolio

such as London, Amsterdam and Berlin, as well as the fact it develops, owns and operates its own sites.

Shares have climbed to around £15 today, giving a 400 per cent return on the investment. However the value of PPHE’s property portfolio was independently valued at around £1.6bn earlier this year, which puts the net asset value per share at just over £24. “That means the stock is currently trading at a discount to NAV of around 34 per cent,” says Santa Barbara. “This is a stock that has done very well for us and we continue to like the story and hold it.”

grow to become a £1bn firm in the years since the fund first backed the stock.

Specialist skillsShe looks for companies with high barriers to entry, which RWS has in the specialist skills and knowledge involved in translating patents outside of their country of origin. It recently acquired another firm that helps big tech companies translate their brand, taking into account not just language, but cultural sensitivities. The share price of RWS has tripled over the past five years from 143p to 467p and, while the team has taken profits, it still likes the stock.

Stevens hopes to deliver similarly strong returns with Medica Group, which she backed when it listed in 2017. The company allows hospitals to outsource reporting on X-rays, CT and MRI scans. Medica’s main customer is the NHS and, although currently only a small proportion of its scan reporting is outsourced, there is huge potential for this to grow.

Once a customer uses Medica’s services they are tied into a multi-year contract and are unlikely to change supplier, resulting in a sticky customer base and high barriers to entry.

Investors who pick correctly in this market of under-researched businesses can be richly rewarded

PERFORMANCE OF STOCKS OVER 5YRS

Source: FE Analytics

Sticky customer baseHe hopes to replicate the success of this holding with Scapa, a global supplier of adhesive products for the healthcare and industrial industries. The AIM-listed business has been increasing its focus on the former, where growth is faster and margins are higher. It specialises in wound dressings and adhesive products to attach to wearable medical devices. Shares are up from 91.5p to 408.4p over the past five years.

Santa Barbara thinks the healthcare side of the business could represent 75 per cent or more of profits in five years’ time. He adds: “The company is going through an interesting transition and that’s where we believe the key growth opportunity lies.”

Victoria Stevens, co-manager of Liontrust Micro Cap, has seen patent translation services company RWS

RWS Holdings PLC (255.96%)

Burford Cap Ltd (1334.72%)

PPHE Hotel Group Ltd (523.97%)

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for the dotcom bubble. Following the bailout of LTCM, the investment mood swiftly became feverish, with the best performing investments defined by their elevator pitch (a simple conceptual story with grand visions) and eyeballs (the gathering of unprofitable user views). Sales of IT hardware and services boomed both to salve the impending ‘Millennium Bug’ and due to an increased desire for personal computers. Those companies that had benefited from this trend became valued as if the good times would never end.

Things are different today, but in some ways they are the same. Once again, investors are excited by concept investments even if the most speculative of them all, the cryptocurrencies, have already disillusioned their fan club. Investors continue to reward the new ‘eyeball’ metric which, these days, is instead unprofitable user growth. Internet shopping, food delivery, ride hailing services, music and video streaming, to name just some, are all subsidised at the point of use by investors. Meanwhile, investors show scant concern that the premium smartphone boom has peaked and have only recently started to consider that companies operating in the ‘Wild West’ space of internet advertising may be about to meet the posse (courtesy of the Facebook data scandal). ■

Even though the late Lawrence ‘Yogi’ Berra was an outstanding baseball player, he is possibly best known for his ‘Yogisms’ – apparently nonsensical comments attributed to him that contain a cryptic life truth. After all, who can disagree that “the future ain’t what it used to be” and “you can observe a lot by watching”. However, this outlook is titled with the Yogism that reflects the resigned inevitability of watching a re-run of a situation you’ve already experienced.

Those who have already read my previous articles will be aware that a simple philosophy underpins our approach to investment. At the core of this philosophy is a recognition that investors are not, in aggregate, dispassionate calculating machines but instead retain human emotions.

As humans, we have many differing emotions, desires and motivations but one apparent constant, which is maintained across cultures and geographies, is a desire to be part of the group. This crowding instinct has been a great benefit to humanity and living standards are unquestionably far higher than if we operated as individuals. Working as a group allows division of labour, specialisation and economies of scale.

However, we believe that this crowding instinct does not usefully translate into financial markets as the crowd is inherently a momentum beast. Crowds naturally gravitate towards what has recently been successful and shun what has recently been unsuccessful. The crowd voice, which is always alluring, is driven by individuals who seek to align themselves with success and disavow failure.

In financial markets, chasing momentum works. Until it doesn’t. By the time an investment has performed sufficiently well (or badly) for it to become an accepted wisdom, conditions are ripe for the trend to change. It is this momentum mentality which creates the business cycle and the numerous bubbles (and subsequent busts) which have bedevilled investment markets.

We do not attempt to follow investment fashions and instead seek investments in which we can foresee long term upside. We actively seek unpopular areas because this is where the balance between risk and reward can be most favourable. Rather than perpetual trends we believe in cycles, which brings us neatly back to the déjà vu referenced in the title.

Investors currently exhibit remarkably low levels of scepticism about ‘hot’ investment themes, particularly in the technology area, which mentally transports us back to the late 1990s when similar enthusiasm reigned (it didn’t last). The collapse of Long-Term Capital Management (LTCM) in 1998 and the subsequent Central Bank response, arguably, created the conditions

IT’S DÉJÀ VU ALL OVER AGAIN

By the time an investment has performed sufficiently well (or badly) for it to become an accepted wisdom, conditions are ripe

for the trend to change.

High conviction, global contrarian investors

For more information visit www.thescottish.co.uk

or follow @ScotInvTrust

The Scottish Investment Trust PLC

RISK WARNINGPlease remember that past performance may not be repeated and is not a guide for future performance. The value of shares and the income from them can go down as well as up as a result of market and currency fluctuations. You may not get back the amount you invest. The Scottish Investment Trust PLC has a long-term policy of borrowing money to invest in equities in the expectation that this will improve returns for shareholders. However, should markets fall these borrowings would magnify any losses on these investments. This may mean you get back nothing at all. Investment trusts are listed on the London Stock Exchange and are not authorised or regulated by the Financial Conduct Authority. Please note that SIT Savings Ltd is not authorised to provide advice to individual investors and nothing in this article should be considered to be or relied upon as constituting investment advice. If you are unsure about the suitability of an investment, you should contact your financial advisor. Issued and approved by SIT Savings Ltd, registered in Scotland No: SC91859, registered office: 6 Albyn Place, Edinburgh, EH2 4NL. Authorised and regulated by the Financial Conduct Authority.Telephone: 0131 225 7781 | Email: info@thescottish.co.uk | Website: www.thescottish.co.uk

ADVERTORIAL FEATURE

by Alasdair McKinnon, manager of the Scottish Investment Trust

FE TRUSTNET

16 / 17Your portfolio

“Cyber security is an area where firms are increasing their spending as the threat of cyber attacks becomes more prevalent”

competition at the time.” Today, the firm has a market capitalisation of almost £3.5bn and Williams has been taking profits as the stock has soared.

Increased spendingA business he is currently excited about is Corero Network, which provides cyber security, an area where firms are increasing their spending.

To date, the most high-profile instances have involved large organisations, but Williams says smaller firms are also taking steps to protect themselves. “These businesses are at risk too and may be easier to target because they have less sophisticated systems,” he explains. He invested in Corero in mid-2016 and, while the share price has since edged down, the firm has recently brought in a new marketing director and won important contracts.

Williams says: “You have a better chance of finding opportunities in small caps, where fewer analysts are looking at businesses and firms may be involved in high-growth areas that are not getting enough coverage.”

Common sense investorsHowever, shares are down from 190p at float to 144p today. “We are common sense investors, looking for real cash-generative businesses we can hold for the long term,” says Stevens. “We want steadily impressive growth with structural tailwinds to the business.”

Gervais Williams, manager of Miton UK Smaller Companies, has had great success with Burford Capital, which provides funding for litigation. He invested when it listed in 2009 when shares were around £1.20 – now they trade at £16.20. Williams says: “It was an immature sector with limited

Return on Burford Capital since IPO in

November 2009

[ JANUS HENDERSON ]

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Open for business

Foreign companies are comfortable enough with the UK’s long-term future to buy up British businesses. Neil Hermon, fund manager of Henderson Smaller Companies Investment Trust, explains why

A way from the media circus surrounding the UK’s exit negotiations with the EU, overseas

companies are quietly taking advantage of the pessimism towards UK equities by buying British businesses at attractive valuations.

Overseas companies are seeing value in the UK; in fact 2017 was the first year since 2011 in which British companies saw a net increase in direct foreign investment. The trend can be seen building from 2015, when there were 145 merger and acquisition (M&A) deals involving overseas investors (inward M&A). In 2016, inward M&A deals increased 80% to 262 and in 2017 there were 259.

The first quarter of 2018 followed suit

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Foreign takeoversSince January 2017, the Trust has profited from 10 M&A deals whereby a company we held in the portfolio was acquired, with seven of those deals involving an overseas buyer.

A recent example of such corporate activity is US private equity firm Silver Lake Partners’ takeover of ZPG Group, which owns property website Zoopla and price comparison service uSwitch. We bought ZPG at 332p per share in January 2017 and sold it for 489p in June, representing a total return of 42.9% over the 18-month period.

Another example is Fenner, a polymer technology firm that provides engineering solutions across a variety of markets. The company was acquired by French conglomerate Michelin this summer for about £1.2bn. We first bought a position in Fenner in April 2017 at 316p and sold it for 609p, representing a total return of 82% in just over 12 months.

These examples demonstrate not only the opportunities for growth investors in the UK’s small and mid-cap markets,

with 75 deals and Q2 statistics show 182 completed inward M&A deals – although this increase is mainly a result of a new methodology for collecting M&A data by the UK’s Office for National Statistics, namely around capturing smaller company deals.

The numbers suggest that if we don’t notice the value in UK equity markets, others will. Henderson Smaller Companies Investment Trust has been a big beneficiary of this trend, with small and medium-sized companies in the UK attracting the interest of overseas companies.

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Advertorial feature 20 / 21

Before investing in an investment trust referred to in this article, you should satisfy yourself as to its suitability and the risks involved, you may wish to consult a financial adviser. Past performance is not a guide to future performance. The value of an investment and the income from it can fall as well as rise and you may not get back the amount originally invested. Nothing in this article is intended to or should be construed as advice.  This article is not a recommendation to sell or purchase any investment. It does not form part of any contract for the sale or purchase of any investment.

 Issued in the UK by Janus Henderson Investors. Janus Henderson Investors is the name under which Janus Capital International Limited (reg no. 3594615), Henderson Global Investors Limited (reg. no. 906355), Henderson Investment Funds Limited (reg. no. 2678531), AlphaGen Capital Limited (reg. no. 962757), Henderson Equity Partners Limited (reg. no.2606646), (each incorporated and registered in England and Wales with registered office at 201 Bishopsgate, London EC2M 3AE) are authorised and regulated by the Financial Conduct Authority to provide investment products and services.  Henderson Management S.A. (reg no. B22848) is incorporated and registered in Luxembourg with registered office at 2 Rue de Bitbourg, L-1273 Luxembourg and authorised by the Commission de Surveillance du Secteur Financier.  © 2018, Janus Henderson Investors. The name Janus Henderson Investors includes HGI Group Limited, Henderson Global Investors (Brand Management) Sarl and Janus International Holding LLC.

but also the confidence overseas investors have in British companies. That message is easily lost amid the furore of Brexit, but there are good reasons why global investors are putting money in the UK.

A Great British brandThe UK is a well established brand with a long history of international trade, and it was considered the easiest place in Europe to do business in the World Bank’s Doing Business report. We have a strong rule of law that shields British businesses from corruption and criminality, and it will remain a strength of UK corporate culture when it leaves Europe’s political union.

The UK is home to some of the best universities in the world and leads in Europe as the number one destination

for higher education. This means UK companies are well placed to recruit top talent from around the world. The country’s central geographic location helped it to become a global superpower, and this could be a supportive factor in developing a new network of trade agreements.

Sterling may have suffered since the referendum – and it could become a source of further frustration as the months roll on – but it remains one of the UK’s strengths. An independent currency and central bank working towards a resilient and robust economy is a huge positive as the UK undergoes this transitional period.

Big opportunities in smaller companiesWe think now is a good time to buy UK small and mid-caps. Valuations are certainly reasonable; the UK market is cheap by international

standards and offers good value relative to historic levels.

We are mindful of the UK’s situation with Brexit negotiations entering their final stages. We might see the UK economy do well or badly on the back of the Brexit deal, which is why the Trust’s portfolio is geographically diverse in terms of revenues; almost half of the sales made by the portfolio companies go overseas. This diversification, we think, is important as we edge closer to the Brexit deadline.

Henderson Smaller Companies Investment Trust has a strong growth bias and a track record of delivering

[ JANUS HENDERSON ]

The UK is home to some of the best universities in the world and leads in Europe as the number one destination for higher education. This means UK companies are well placed to recruit top talent from around the world

superior total returns for shareholders over a medium- to long-term horizon. In fact, the Trust has outperformed the Numis Smaller Companies Index on a total return basis in 14 of the past 15 financial years.

A £1,000 lump sum investment in the Trust on 31 October 2002 would now be worth £12,577 (as at 30 October 2018), with a compound return of 17.4%. That’s not to say we are going to live off past glories, because they won’t guarantee future results, but we will continue to employ the same principles and consistent strategy that has rewarded our shareholders.

22 / 23Your portfolio

Finding its feet

After decades in the doldrums, the Alternative Investment Market (AIM) has finally begun to outperform. Daniel Lanyon considers the best way to access this area

F orget Brexit for a moment, if at all humanly possible, and consider a more important question investors should be

asking. Where to find the high-growth companies of tomorrow?

Should you look for private companies in disruptive markets instead of publicly listed ones? The fast-expanding economies of tomorrow such as India or China? Or stick to gorging on Silicon Valley’s next tech giants?

Investors who prefer their home comforts may be tempted to look down, tempted by the potential for stellar returns from micro caps. However, while the Alternative

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While AIM has become a successful hunting ground for stockpicking investors since its launch in 1995, it has been the scene of some absolute stinkers, too

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[ AIM ]24 / 25Your portfolio

Investment Market (AIM) has become a successful hunting ground for stockpicking investors since launch in 1995, it has been the scene of some absolute stinkers, too. Patisserie Valerie’s recent accounting scandal is one example where a company has gone from a promising outlook to struggling for survival in a matter of hours, following in the footsteps of Conviviality earlier this year.

Massive underperformanceHistorically, the AIM index has also massively underperformed the main market. FE Analytics has data on the market going back to 1998 – since then, its gains of 18.32 per cent are one-10th of those delivered by the FTSE All Share and are less than half the 51.21 per cent increase in inflation. Had you invested at the worst possible moment, towards the beginning of 2000, you would still be sitting on losses of more than 50 per cent.

Over the past three years, however, the picture seems to be reversing, with AIM up 37.86 per cent compared with 25.37 per cent from the FTSE All Share. So what’s been going on? And is this a flash in the pan or a sign the market has finally found its feet?

One reason for the recent turnaround may be the growth in dividends paid by AIM stocks, which tripled

in the period between 2012 and 2018, a growth rate four times higher than the main market’s.

The default choiceJason Hollands, managing director of

Tilney, says AIM is now the default market for small-cap IPOs because rules are less onerous, costs are lower and there is no minimum free-float requirement. Entrepreneurs and

families can therefore maintain a high stake in their business

while simultaneously accessing external capital

and achieving greater visibility on the value of their stakes.

However, he warns that this comes at a price, describing

AIM as “undoubtedly a minefield” where

companies receive far less scrutiny than those on the main exchange – helping to explain the fate of Conviviality and Patisserie Valerie.

Disruptive technologyLaura Foll, co-manager of the £282m Henderson Opportunities Trust, says the next generation of companies capable of disrupting existing industries are mostly found on AIM – which is why nearly 60 per cent of her portfolio is invested in this area.

“There is the opportunity to invest in sectors you might otherwise struggle

One reason for the recent turnaround may be the growth in dividends paid by AIM stocks, which tripled in the period between 2012 and 2018

FTSE AIM All Share (18.32%)

UK Consumer Price (51.21%)

FTSE All Share (205.70%)

Source: FE Analytics

PERFORMANCE OF INDICES SINCE MAR 98

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*Ongoing charges as at 31.03.18. **Source: Morningstar, share price, total return as at 30.09.18. Your call may be recorded for training or monitoring purposes. Scottish Mortgage Investment Trust PLC is available through the Baillie Gifford Investment Trust Share Plan and the Investment Trust ISA, which are managed by Baillie Gifford Savings Management Limited (BGSM). BGSM is an affi liate of Baillie Gifford & Co Limited, which is the manager and secretary of Scottish Mortgage Investment Trust PLC.

SOME OPPORTUNITIES ARE MORE EXCLUSIVE THAN OTHERS.A company’s ability to exhibit exponential growth lies at the heart of the Scottish Mortgage Investment Trust, managed by Baillie Gifford.

Our portfolio consists of around 80 of what we believe are the most exciting companies in the world today. Our vision is long term and we invest with no limits on geographical or sector exposure.

Baillie Gifford’s track record as long-term, supportive shareholders makes us attractive to a new breed of capital-light businesses. And our committed approach means we can enjoy a better quality of dialogue with management teams at transformational organisations such as Alibaba, Dropbox and Airbnb. So it is a case of who you know as well as what you know. Over the last fi ve years the Scottish Mortgage Investment Trust has delivered a total return of 206.2% compared to 110.2% for the sector**.

Standardised past performance to 30 September**:

2014 2015 2016 2017 2018

Scottish Mortgage 27.6% 4.2% 37.0% 30.4% 29.0%

AIC Global Sector Average 11.2% 7.1% 24.4% 22.7% 15.1%

Past performance is not a guide to future returns.

Please remember that changing stock market conditions and currency exchange rates will affect the value of the investment in the fund and any income from it. Investors may not get back the amount invested.

The Trust’s risk could be increased by its investment in unlisted investments. These assets maybe more diffi cult to buy or sell, so changes in their prices may be greater.

For some very exclusive opportunities, call us on 0800 027 0132 or visit us at www.scottishmortgageit.com

A Key Information Document is available by contacting us.

COSTS MAKE A REAL DIFFERENCE TO PERFORMANCE – OUR ONGOING CHARGES ARE JUST 0.37%*.

SCOTTISH MORTGAGE INVESTMENT TRUST

Long-term investment partners

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to get exposure to. When you think of the whole of the UK large cap [equity] market, there is not much of a tech sector. In AIM, you can find lots of really exciting technology companies,” she adds, pointing to Blue Prism, the fund’s largest holding, as an example. The stock, which sells back-office automation software, has returned more than 1,600 per cent since its IPO in 2016.

Foll says the low regulatory touch has its downsides too and because

26 / 27Your portfolio

The next generation of companies capable of disrupting existing industries are mostly found on AIM

Many – but not all – AIM stocks are eligible for Business Relief once they have been held for two years, which means they become exempt from the investor’s estate for inheritance tax purposes.

This has resulted in considerable inflows in recent years through discretionary managed AIM

portfolio services aimed at helping investors mitigate this levy.

Estimates vary, but these collectively represent a meaningful slice of the market which in turn could be fuelling premium valuations on some stocks, Hollands says.

Ben Conway, co-manager of the Hawksmoor

Vanbrugh and Distribution funds, says this is one of the reasons AIM stocks have become expensive, but he points out there are still bargains to be had.

“The AIM index has seen a huge inflow from IHT-planning assets and as such I would urge investors to think carefully about investing in a large AIM-only portfolio.”

Tax advantages

liquidity is lower, it can take longer to rotate out of positions.

“Compared with the main market you have to be very well aware that the door can shut behind you [in the short term],” she adds.

Hawksmoor’s Ben Conway prefers to use Polar UK Value Opportunities and Man GLG Undervalued Assets, both all-cap mandates, to access this area. Hollands also prefers an all-cap approach, saying there is little need for investors to hunt out a niche AIM fund. He favours Liontrust UK Smaller Companies, managed by Anthony Cross and Julian Fosh.

Foll says there is another, unexpected benefit to the all cap approach: “It lets you see which of your large caps are about to be disrupted.”

In focus

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28 / 29 [ FUND ]

Source: FE Analytics

MANAGER: Stephen Yiu / LAUNCHED: 11/09/2017 / FUND SIZE: £80M / OCF: 0.92%

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FACT BOX

FE CROWN RATING

LF Blue Whale Growth (11.94%) IA Global (-0.53%)

LF Blue Whale Growth

Stephen Yiu’s fund was launched little over a year ago, but appears to have hit the ground running

B acking a new fund or younger manager with a limited track record can be a risky tactic.

However, investors brave enough to commit their money to a recently launched strategy can benefit from a fresher way of thinking – for example, by steering clear of the major asset management firms they can avoid the “groupthink” that results from their use of the same sell-side research.

This was one of the reasons that compelled Stephen Yiu to launch his own asset management firm, Blue Whale Capital, along with Hargreaves Lansdown co-founder Peter Hargreaves. Yiu previously worked at some of the UK’s most prestigious fund management companies such as New Star (which was acquired by Janus Henderson) and Artemis, where he co-managed an £800m strategy.

Yiu has a simple investment philosophy – he believes it is possible to achieve outsized investment returns

PERFORMANCE OF FUND VS SECTOR YEAR-TO-DATE

when the market underestimates the long-term growth potential of a stock’s sales and earnings. His strategy has two steps: firstly, finding companies that can grow over time and improve profitability, and secondly, buying them at a good price.

Blue Whale’s first fund, LF Blue Whale Growth, is a high-conviction strategy with a heavy technology bias due to Yiu’s belief this sector will continue to grow and deliver strong returns over the long term. It seems to be working so far – the fund’s gains of 11.94 per cent this year put it fourth of 299 funds in the IA Global sector, where the average return is a loss of 0.72 per cent – a figure Yiu describes as simply not good enough.

“By looking at the returns of the 300 funds in the IA Global sector, actually the average fund underperforms and you will be asking, ‘what is the point of picking a manager if it is likely that he underperforms?’ You may as well

buy a tracker. It is sad, but it is what is happening,” he said.

“Every active manager should be aiming to deliver at least 5 percentage points of outperformance per annum over a cycle to justify their fees.”

“It is not impossible, but it is a lot of hard work, there is nothing magical about it. I wouldn’t claim we have any

special formula, but we do what is supposed to be done. However, other people don’t.”

One satisfied customer in Yiu’s fund is Hargreaves, who said: “I don’t think I have ever made an investment that has returned this much to me in its first year. It has been the best-performing fund in my portfolio.”

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30 / 31 [ PENSION ]

IT Hedge Funds (4.09%)

MSCI AC World (1.69%)

Brevan Howard Capital Management - BH Macro (29.90%)

Source: FE Analytics

BH Macro

This hedge fund-style strategy feeds off volatility, making it a potentially useful diversifier with the end of the cycle approaching

C onventional wisdom would suggest you increase your exposure to bonds at the de-

risking stage of your retirement. However, with yields low and likely to rise, this option currently looks unappealing.

One alternative for reducing risk in your portfolio is BH Macro, a trust that Peter Hewitt is using as a diversifier against the more growth-orientated names in F&C Managed Portfolio Trust Growth.

BH Macro is fully invested in the Brevan Howard master fund which is a macro-style hedge fund.

While the trust has disappointed over large parts of the last decade – from 2010 to 2018 it returned just 43.03 per cent, for example – it does offer genuine diversification.

It does not invest in equities but instead makes interest rate and

PERFORMANCE OF TRUST VS SECTOR AND INDEX YEAR-TO-DATE

foreign exchange trades. It therefore feeds off volatility, meaning the extended period of market stability in the run-up to 2018 acted as a headwind. This all changed this year, however, with the unpredictable conditions helping to push the trust up by 27.41 per cent, compared with gains of 1.17 per cent from the MSCI All Countries World index.

Take May 2018, for example. The trust was short Italian bonds heading into the general election on the expectation that extremist parties would make better gains than those in France and Germany had done last year.

In that month alone, the portfolio saw its net asset value climb by nearly 9 per cent.

The trust also did extremely well during the global financial crisis, returning more than 20 per cent in

both 2008 and 2009 at a time when equity markets were tanking.

Therefore, it could be one option to hedge against further instability with the end of the cycle approaching. Numis Investment Companies recommends the trust as a core buy, describing it as an

attractive portfolio diversifier at a time of increased volatility in equity markets.

However, this diversification doesn’t come cheap and although the trust is trading at a small discount, it has hefty ongoing charges of 2.11 per cent.

MANAGER: Brevan Howard Capital Management / LAUNCHED: 14/03/2007 / PREMIUM/DISCOUNT: -3.5% / OCF: 2.11%

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32 / 33 [ TRUST ]

Herald Investment Trust (658.50%)

IT Small Media, Comms & IT (656.78%)

Numis Smaller Companies + AIM Excluding Investment Companies (418.39%)

Source: FE Analytics

MANAGER: Katie Potts / LAUNCHED: 16/02/1994 / PREMIUM/DISCOUNT: -14.97% / OCF: 1.08%

FACT BOX

FE CROWN RATING

Herald Investment Trust

Katie Potts’s trust represents one way for tech investors to diversify away from the FAANGs

W hile most people will think of mega-cap growth names such as Apple or Google

when the subject turns to tech, focusing exclusively on this area can see them miss out on the substantial gains that can be achieved further down the market cap scale.

Or at least, that’s the premise of the £819.9m Herald Investment Trust, which has been headed up by Katie Potts since launch in 1994, making her one of the longest serving managers in the industry.

Herald aims to achieve long-term growth through investing in the communications and multi-media sectors and the providers of services to these areas.

As such, the manager has a 5,000-strong universe of quoted stocks to invest in, as well as many more unlisted names.

“We are evangelists for the sector and firmly believe investors are missing an

PERFORMANCE OF TRUST VS SECTOR AND INDEX OVER 20YRS

opportunity if they are not represented in it,” the firm noted.

Just over half of the 282-stock portfolio is held in UK assets (54.4 per cent) with a quarter in the US. Potts says this is because valuations of domestically based stocks look much more attractive than their peers across the Atlantic, despite the uncertainty caused by Brexit.

She also pointed to a number of successful small cap stocks in the UK that have made the step-up to the FTSE 100, such as Sage.

The portfolio contains a high concentration of profitable companies with a recurring revenue model, “in order to provide ballast in an uncertain economic environment”, and more disruptive companies with higher growth potential participating in new markets.

While the trust focuses on the smaller end of the market cap scale, UK investors may be familiar with some

of its top holdings such as market research firm YouGov, magazine publisher Future, and online estate agent Purple Bricks.

Its largest holdings are UK-based identity data specialist GB Group and semi-conductor company IQE.

The trust has delivered a 658.5 per

cent return over the past 20 years, compared with 656.78 per cent from the IT Small Media, Comms & IT sector and 418.39 per cent from the Numis Smaller Companies + AIM index.

It is trading at a discount of 14.97 per cent, slightly below its three-year average of 17.44 per cent.

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34 / 35

Adam Lewis runs the rule over small cap-funds in every major global region

Small world

F or anyone willing to stomach the extra volatility, investing in smaller companies has long been

perceived as a more appropriate strategy for investing for growth than going down the large cap route.

This is not just true for the UK. Data from FE Analytics shows that small cap sectors account for four of the six best performers over the past 20 years, and four of the five best over 10. “The outperformance has been true whether measured on a straight cumulative return basis, or a percentage of discrete years,” says Chris Metcalfe, investment director at IBOSS.

The trade-off for this performance has been the perception that investors are taking on more volatility, but looking at data from the last decade shows this is not always the case.

“The outperformance has been true whether measured on a straight cumulative return basis, or a percentage of discrete years”

In focus [ SECTOR PROFILE ]

Take the IA European Smaller Companies sector, for example. The average fund is up 288.4 per cent over 10 years, achieving this gain with an annualised volatility of 15.43 per cent. Over the same time period, Europe ex UK has returned 167.21 per cent, but with an annualised volatility score of 15.93 per cent. So in the case of Europe, investors have actually had a more volatile ride in the wider sector, but for lower gains.

counterparts in China, although many investors have avoided this sector in part due to the perception that smaller companies in this region are more volatile. However, Tiffany Hsiao, manager of Matthews Asia China Small Companies, says this is not the case.

“The reality is that small caps tend to be less volatile than large-cap Chinese stocks because not only are they less dependent on what takes place at an economic level, they also carry less debt,” she says.

Anonymity advantage“Smaller companies provide opportunities for higher growth at lower valuations as they are less well known. This allows active managers such as ourselves to uncover opportunities among high-quality companies with good corporate governance at lower valuations.”

The stomach for it“It is worth noting that in the large market downturn years such as 1997, 2000, 2001 and 2008 the four small cap sectors had significantly larger drawdowns,” cautions Metcalfe. “However, if you can stomach the extra volatility and occasional larger drawdown, small caps would appear to be the way to go.”

This outperformance is not confined to developed markets, either. Small caps have also beaten their larger

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36 / 37In focus [ SECTOR PROFILE ]

Source: FE Analytics

Across Asia as a whole, excluding Japan, smaller companies now represent more than 8,000 publicly-listed stocks, ranging from $100m to $3bn in market cap.

Hsiao adds: “Fundamentally our research shows that small caps as an asset class are inherently companies that rely on self-generated capital. By not being so dependent on financing, in volatile times – with interest rates rising and a focus on deleveraging – their costs are not impacted as much as they are for large caps.”

That trade-offJohn Husselbee, head of multi asset at Liontrust, notes that the classic theory of markets is that long-term active management works best for strategies that are both tilted to value and smaller companies. In the case of the latter, this is because such companies are less researched by analysts, leading to opportunities for active managers to add alpha.

The trade-off is that by being less liquid, such companies get hit harder in market sell-offs. It was the domestic small and mid cap stocks that were hit hardest in the immediate aftermath of the UK’s vote to leave the EU in 2016, for example, as investors retreated to the relative safety of the FTSE 100, whose companies rely more on earnings from overseas.

Husselbee says that Liontrust treats US, UK, European and Japanese small caps as asset classes within their own right, rather than as part of its general exposure to these regions.

“In a globalised world, many large caps generate their profits and earnings overseas, meaning that if you want more of a pure play on domestic economies, you need to invest in small and mid caps,” he explains. “At the same time, small caps provide a different risk versus reward experience to large caps, adding diversification to enhance returns over the long term.”

Brexit beneficiariesOn the basis that the beneficiaries of a soft Brexit will be small caps, Husselbee is happy to have a neutral weighting to the asset class, while similarly in the US he says they represent a good play on the strength of the domestic economy.

“In Europe and Japan we are overweight in both the wider regions and small caps,” he adds. “When it comes to Asia and emerging markets, while you can buy smaller company funds, at present there is not enough choice to make us separate them out as asset classes.”

For Metcalfe there is another alternative which can provide a potentially smoother ride for investors, while not sacrificing the potential for extra gains that small caps can provide.

“We look for funds which are still small and nimble enough to invest in small- and mid-size companies, but which use a multi-cap approach,” he says. “We have found this works particularly well in the UK all-cap space, which has an ample supply of relatively small funds with outstanding track records.”

“In a globalised world, many large caps generate their profits and earnings overseas, meaning that if you want more of a pure play on domestic economies, you need to invest in small and mid caps”

BEST PERFORMING IA SECTORS OVER 10YRS

Name 1yr (%) 3yr (%) 5yr (%) 10yr (%)

IA Technology & Telecommunications 5.61 69.16 105.52 384.23

IA North American Smaller Companies 7.78 62.68 82 337.37

IA UK Smaller Companies -3.69 32.28 55.01 326.72

IA Japanese Smaller Companies -0.33 70.03 90.81 315.36

IA European Smaller Companies -7.17 39.64 57.7 288.4

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38 / 39In focus [ SECTOR PROFILE ]

UKJanus Henderson UK Smaller CompaniesWhen it comes to the UK, Husselbee’s preferred choice is the £161m Janus Henderson UK Smaller Companies fund, managed by Neil Hermon. While the fund is ranked third quartile over one and five years, its gains of 459.02 per cent over the past decade are well above the 326.72 per cent made by the IA UK Smaller Companies sector. Husselbee also points to

the experience of Hermon, who has managed money for over 20 years and runs the Henderson Smaller Companies Investment Trust and Janus Henderson UK Alpha fund. At just £161m, the fund is still small.

Europe Barings Europe Select TrustHusselbee’s pick of the 25 funds in the IA European Smaller Companies sector is the £1.96bn Barings Europe Select Trust.

“When it comes to smaller companies investing it is all about looking for managers with experience,” he says. “The European small cap space is under-researched so we want managers who can work through it and manager Nicholas Williams has a proven track record.” The fund is first quartile over one and three years and second quartile over five. It has made 384.12 per cent over the past decade, compared with 288.4 per cent from its sector.

The USJPM US Smaller CompaniesWith a return of 414.85 per cent, JPM US Smaller Companies is the second-best performer of nine funds in the IA North American Smaller Companies sector over the past decade and is also ranked first quartile over one, three and five years. Husselbee notes that like many of its peers, the fund has a strong bias to tech, with the sector accounting for 25 per cent

of assets. It is headed up by Eytan Shapiro and Timothy Parton who recently said: “Healthy corporate earnings and sustained strength in economic indicators should provide continued support to the equity market.”

Japan M&G Japan Smaller CompaniesHusselbee’s choice of the seven IA Japanese Smaller Companies funds is M&G Japan Smaller Companies, run by Johan

Du Preez and John Lothian since September 2015. The managers aim to take advantage of the way emotions cause irrational pricing, buying companies if it believes the market is underestimating their long-term potential. “While the fund has more of a value tilt than its peers, over the long term it has done well,” says Husselbee. The fund has made 415.99 per cent over the past decade, compared with 315.36 per cent from its sector. It is £274m in size.

Key statisticMetcalfe highlights SVM UK Growth, Unicorn Outstanding British Companies, Slater Growth and Marlborough UK Multi-Cap Growth as the kind of funds he looks for.

“These managers take away the pressure of having to make the cap call,” he says. “The key statistic we need to watch for, other than performance, is the fund size. This is why we favour boutique-style companies which have less of a land-grab approach, based on scooping up assets as quickly as possible.”

Metcalfe notes that perversely a fund that does not market itself particularly

“We look for funds which are still small enough to invest in small- and mid-size companies, but which use a multi-cap approach”

PERFORMANCE OF FUNDS OVER 10YRS

Source: FE Analytics

Janus Henderson UK Smaller Companies (459.02%)

M&G Japan Smaller Companies (415.99%)

JPM US Smaller Companies (414.85%)

Barings Europe Select Trust (384.12%)

heavily or successfully is at something of an advantage in this area.

“We have adopted a similar approach in Europe, where we have used Miton European Opportunities for almost two years,” he says. “The fund was only launched in December 2015, but has a successful management team which dates back to 2005 and invests on an all-cap basis, with a bias to mid and smalls.”

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Data hub

Crunching the biggest trends down into figures

40 / 41

Source: Numis Smaller Companies Index Annual Review 2018, London Business School; Liontrust; Aberdeen Standard Investments; Stock Challenge; FE Analytics; FTSE Russell

FE TRUSTNET

– compound annualised return of Numis Smaller Companies Index

since launch in 1955 – 3.4 percentage

points more than the FTSE All Share

– value now of £1,000 invested in ASOS at flotation in 2001

£4.8bn

86.2%

£232,170

£720,900

AIM’s largest stock ASOS is the 96th largest in the UK market

of the FTSE All Share’s 642 companies, but just

of its £24.3trn market cap

The FTSE Small Cap accounts for

best-performing IA sectors over

10 years focus on small caps

– AIM’s maximum drawdown since launch

– value now of £100 invested in Numis Smaller

Companies Index since launch in

1955 – compared with £109,500

from the FTSE All Share

15.2%

45%

3.7%

Big opportunities in small caps

4 of the 5

Small caps outperformed in 19 of the 21 largest FTSE World countries from 2000 to 2017

42 / 43In the back

Crash dummies

AltRetire’s John Blowers says timing the market to avoid a correction is a mug’s game – and advises focusing on three other variables instead

Nobody likes to see their portfolio is worth a lot less than it was a few months ago, but investing isn’t a linear activity

[ PLATFORMS & PENSIONS ]

than the finish point, which means that you’ve lost real money.

For example, if I’d invested £100,000 in a FTSE 100 tracker at the start of September 2000 and sold it the best part of a decade later, at the start of March 2009, even with dividends reinvested I would have got back just £76,151.73 – a staggering loss of almost £24,000.

And this is what continually gnaws on our subconscious as investors. What if that happens to me?

However, those of us with a glass half-full disposition would say that if I’d put £100,000 in at Christmas 1989 and cashed in 10 years later, I’d now be holding a cheque for £428,622.31 – a whopping £328,622.31 gain.

equal measure, but it doesn’t make for easy planning.

This is the point in every article where the writer will fish out a chart of the FTSE 100 and show the end point is always higher than the start, so what are we worried about? I have done the same here.

The point to note is that over the last 35 years there are plenty of scenarios in which the starting point of your investment journey has been higher

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S ome people with the gift of hindsight will tell you there are points in the stockmarket cycle when you should sell

out of equities, allowing you to avoid the worst of a correction and buy back in before the inevitable rebound.

And if you had done this, you would have made a veritable fortune.

Imagine selling all of your holdings at their highest value and then buying the very same ones for 20, 30 or maybe even 40 per cent less, before watching them grow again over the next bull run.

The fact is, nobody – not even the most respected investment professionals – can time the market with any level of accuracy or success.

Trying to sell at the top is fraught with danger. Will I sell too soon? When is the top of the market?

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The chances are you’ll go too early, or worse too late and miss that moment. Then there are all the transaction costs and the question of what to do with all the cash that you have generated.

Then you have to call the bottom of the market. Again, you’re likely to buy back in too early or too late for the exercise to be worthwhile.

This is why some of our most respected investment professionals tend to offer the advice “buy and hold”.

Nobody likes to see their portfolio is worth a lot less than it was a few months ago, but investing isn’t a linear activity and although the market is cyclical, you cannot predict the extent of a correction, nor the length of time it will last. I suppose it makes it exciting and fear-inducing in

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44 / 45In the back [ PLATFORMS & PENSIONS ]

Fear & greedAs private investors, what’s the best way to deal with these conflicting emotions of fear and greed? Of course, we want to make money as it is a major driver as to how comfortably we will fund retirement as well as lesser needs such as paying off a mortgage, funding a second home, a wedding or a car and so on.

Building-society savings limit the upside gains we can make – especially in this long-term, low interest-rate world – but they do also limit the downside.

There are three key elements to consider when you invest: time horizon, risk and charges. These are all within an investor’s control, more now than ever before.

Planning and managing these three elements will help you deal with the emotional conflicts you have as an investor and may help you to avoid the behaviour investors exhibit prior to losing money.

Source: FE Analytics

GROWTH OF £100K INVESTED IN FTSE 100 SEP 00 – MAR 09 FTSE 100 (£76,151.73)

50,000

60,000

70,000

80,000

90,000

100,000

110,000

120,000

130,000

Sep00Mar0

1Sep

Mar02

Sep

Mar03

Sep

Mar04

Sep

Mar05

Sep

Mar06

SepMar0

7Sep

Mar08

Sep 09

Most UK investors are planning for retirement and most companies have pretty much set a date for this event. At present, it is 65 years old and you are expected to stop work at this point in favour of gardening and Rhine cruises. In the past, if your retirement date coincided with a market correction or crash, you were in pretty big trouble, particularly if you were buying an annuity.

Now the landscape is more flexible, with pension freedoms letting you access your pension pot from the age of 55 and leave it in the market for as long as you wish.

By leaving your pension fund invested (and resisting the temptation to blow it all on a Lamborghini), you are not tied to selling at a low point in the market. If your retirement does coincide with a market crash, try to

leave it alone and generate your living costs elsewhere (possibly a property downsize, other cash savings, or liberating other assets). When your portfolio recovers (as it historically always has), you can then use that as your income source in retirement.

Remember the value of your portfolio is only realised when you sell it – beforehand it’s just a number.

Time horizon

RiskUs Brits hate this word. But risk and return go hand-in-hand and if you want to turbo-charge your investments, you should consider taking more risk up to and beyond your retirement date.

Popular advice is always to take less risk as you approach retirement to limit downside, but in reality, everything goes down in a crash and lower-risk investments just won’t come back. Yes, they fall less, but they rise less, too.

Unless you have a fortune you want to preserve or a pressing need to access capital, you should invite risk into your portfolio so that it grows along with life expectancies.

I’m not saying invest in Bitcoin or gold miners, but there are many excellent higher-risk funds from blue-chip asset managers out there with excellent and consistent track records. You’ll find many highly rated funds on the FE Trustnet website.

Finding consistent top-performers is intrinsically tied in with risk and I’d rather bank on a decent fund run by a manager more familiar with market timing than ever attempt to stock-pick and day-trade myself.

My own portfolio is testament to that, with all of my worst performers being direct equity investments. Give me Terry Smith rather than Rolls Royce any day!

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46 / 47In the back [ PLATFORMS & PENSIONS ]

Source: FE Analytics

GROWTH OF £100K INVESTED IN FTSE 100 JAN 90 – JAN 00 FTSE 100 (£428,622.31)

329%FTSE 100’s return between 1990 and 2000

50,000

100,000

150,000

200,000

250,000

300,000

350,000

400,000

450,000

Jan90

Jan91

Jan92

Jan93

Jan94

Jan95

Jan96

Jan97

Jan98

Jan99

Jan00

Higher-risk investments tend to fall more in the short term but rise more in positive markets, leaving lower-risk investments trailing in their wake over time

If you manage your investments yourself or use an adviser, both will take a percentage of your portfolio as a fee, whether you’re making or losing money.

Some people think paying an extra 2 per cent here or there won’t make a big difference. But it really does.

If you are paying 2 per cent to advisers and fund

managers each and every year, in good times and bad, it could mean you end up with hundreds of thousands of pounds less in your portfolio at retirement.

The first thing we’ve grasped is that the market goes up and down. Until recently, it’s been doing a lot of going up, with the FTSE 100 threatening to touch the 8,000-point level.

Suddenly it shed more than 800 points in the October correction and portfolios are looking gloomy. Nobody knows if this is a blip or further declines are on the cards. Nobody knows how long it might take to get back to pre-October levels. Or if it ever will.

But markets have historically risen over time, so patience and flexibility are also key considerations. Don’t depend on encashing your portfolio on a certain date.

We’ve also learnt that risk can be a good thing. Higher-risk investments tend to fall more in the short term but rise more in positive markets, leaving lower-risk investments trailing in their wake over time. Again, flexibility and patience are important skills.

And we’ve learnt that, along with death and taxes, charges can be a bit of a spoiler, but we can control how much we pay for funds, platforms and advisers. Always check that you’re not paying more than you have to for the value that you receive.

Finally, we’ve learnt not to let emotion rule our investment decisions and not guess what the market is going to do. Buy and hold.

Keep an eye on these three elements of your investing life and you can feel a little more relaxed about the ups and downs of the rollercoaster that we’re all travelling on.

Charges

What have we learnt?

[ STOCKPICKER ]

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In the back 48 / 49

There are still “hidden growth” stocks that offer exposure to rapidly expanding businesses at attractive pricesSecret

success

CRUX UK Special Situations’ Richard Penny names three UK stocks whose growth is underappreciated by the market

O ctober’s sell-off across global stock markets has had the greatest impact on growth

shares. While the underperformance of this sector has affected some of the UK’s best and most expensive companies,

PrudentialSometimes growth divi-sions tucked away in larger companies can trade at a discount to their under-lying value. Prudential’s Asian subsidiary is not exactly a secret and the shares have been strong performers over recent years. However, analysts still believe the company trades at a discount and,

valuing its operation in a similar way to AIA, a pure play on the sector, suggests upside for the shares. Recent emerging market problems have dented sentiment far more than the long-term pros-pects for Prudential, but we believe an upcoming showcase of its Asian divi-sion to analysts, and next year’s de-merger of its UK operation, should act as catalysts.

JadestoneAcquired growth can be dangerous, with up to two-thirds of deals harming the value of buyers. Manage-ment teams can overpay for assets, often because they are rewarded for build-ing scale instead of creat-ing wealth. However, we believe Jadestone’s acqui-sition of Montara in Aus-tralia is a shrewd purchase.

The management, which founded the business, has a record of operating and improving oil & gas assets. After turning down many transactions, it bought Montara, an orphan asset in a large company, for a bargain price. The oil price has risen since then and we think management can improve its performance, even though there is upside if current production levels are simply maintained.

Alpha FMCWe take a Goldilocks ap-proach to growth invest-ments: we don’t invest while a company is unprov-en, but we don’t wait until the market is pricing in its prospects. One Goldilocks investment is Alpha FMC, a consultant to the fund man-agement industry. The firm targets the best employees of PWC and Accenture,

rewarding staff with equity in the business. Its lack of expensive sales partners or graduate recruits means Al-pha FMC is a lean company and boasts higher produc-tivity per consultant, em-ploying just 350 people in these positions, compared with 500,000 at the Big Four. The company floated in 2017 with a strong record of organic growth, which is expected to continue over the next decade.

many stocks still look expensive and could have further to fall. However, there are still “hidden growth” stocks that offer exposure to rapidly expanding businesses at attractive prices. Here are three of the best.

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[ WHAT I BOUGHT LAST ]In the back 50 / 51

Tom Sparke is an investment manager at GDIM Discretionary Fund Managers

Funds that effectively allocate capital will always catch the eye but highly efficient performance in more volatile areas is even more valuable

Looking at the fund’s current holdings brings a mix of reassurance and curiosity as some unfamiliar names populate the top-10.

Janus Henderson Asia Pacific Capital Growth has a focus on high-quality stocks but also demonstrates value-based characteristics in not over-paying for companies, while actively topping up or initiating positions in securities the team believes are over-sold. In the third quarter of this year, the managers felt that quality growth companies were

expensive, so lightened up on some technology holdings and added to some financials, consumer discretionary and commodity stocks.

If, as expected, the recent volatility subsides and more fundamental factors, such as earnings, begin to drive Asian markets once again, this fund should be able to capitalise on its favoured stocks with strong earnings and continuing healthy domestic demand.

Funds that effectively allocate capital will always catch the eye but highly efficient

Janus Henderson Asia Pacific Capital Growth

This fund operates in a high-growth area, but GDIM’s Tom Sparke is most impressed by its focus on downside protection

L ooking across the market for optimal areas of

growth over the next few years, it is hard not to settle upon assets in emerging markets, especially in Asia. It is no secret that China is well on the way to surpassing the US as the world’s largest economy, that India’s enormous young workforce will drive substantial and persistent growth or that South Korea’s semiconductors power a huge percentage of the world’s devices.

When looking at how to increase our exposure

to this region, “risk-adjusted return” was a key consideration. So, when it came to the Janus Henderson Asia Pacific Capital Growth fund, a high-conviction best-ideas portfolio run by an experienced team, the degree of downside protection it had achieved was one of its most attractive features. The fund has managed to keep up with its peers when markets have rallied but held up much better when they have fallen.

The fund’s management team is headed up by Andrew

Gillan and contains nine other managers and analysts, all of whom contribute ideas. They split the portfolio into two categories of stocks, core and dynamic, with the former containing familiar secular growth companies such as TSMC, Samsung and Tencent, and the latter more cyclical names or those just emerging as winners. The fund can invest across the Asia Pacific region and typically holds substantial weights in China, India, Taiwan and Hong Kong, which dominate the portfolio.

performance in more volatile areas is even more valuable and we are pleased to welcome the fund into both our higher risk portfolios and our more moderate ones, too.

December preview

Was that it?The next issue of FE Trustnet Magazine will feature our traditional end-of-year review as we try to find out what

happened to the bull run that all the experts were banking on 12 months ago.

More important than looking back, however, is looking forward, as we give our outlook on every major sector and

region in 2019 and find out where the experts will be putting their money in the year ahead.