Given current market conditions, whereby COVID-19 has caused a massive global sell-off, there will be many investors who will want to stick with quality mega caps in the belief that these firms are of such a scale that they can shake-off the current market malaise. However, speaking to Dan Harlow (pictured), manager of AXA Investment Managers Framlington UK Smaller Companies Fund, while he views that some of his 70 odd holdings may feel the pain more than others, holiday firm On the Beach being a prime example, he’s certainly not panic selling.
“We believe in the long-term outperformance of small caps versus the FTSE All Share. If you identify those companies with growth potential, for instance those who have pricing power and can control market share, we should be able to identify the large caps of tomorrow,” Mr Harlow tells Fundeye.
His fund differs from some small cap competitors in that it has around 15 percent in the FTSE 250. He didn’t pick stocks from this segment of the market, it’s indicative of the quality of his stock picking prowess that firms have grown in market cap to be elevated to the FTSE 250. He mentions that the firm has a fund that specialises that in mid cap companies, whereas his picks tend to be in the small cap or even AIM-listed space.
A quick glance at his portfolio shows that Mr Harlow has certainly picked out some real winners. For instance Keywords Studios, a support service company to the video game industry is one of the famed ’10-baggers’ its share price increasing by at least 10-times since IPO. He’s taken some profit from the company although as the firm continues on its upward march using a mixture of organic growth as well as bolting on specialised firms, he explains its success saying, “They want to be a one-stop shop provider, the clients they serve are very savvy, the more its clients trust them the more they outsource [to Keywords].”
Another firm that has successfully adopted a ‘buy and build’ approach is Learning Technologies Group. The company’s CEO Jonathan Satchell, aware of what some market participants view as a dangerous way to grow companies, said his company is “unashamedly so [buy and build]”. The firm’s transformational deal with NetDimensions a few years led to a more than tripling of the share price once the deal bedded in, this is the sort of performance investors want from a growth fund.
Given the size of the fund, which like the wider market has not escaped the reaches of the coronavirus, it should not be affected by capacity issues that plague some small cap funds when they grow too large. With assets under management of over £200 million, it has over 50 percent invested in companies with under £400 million market cap. As Fundeye has previously reported, one issue that small cap funds need to keep on top of is liquidity issues but while AXA IM would most definitely like a greater AUM, at its current level it shouldn’t be problem of having too great a concentration in one stock (which can lead to issues regarding damaging the share price if it wants to take some profit from a company).
However, Mr Harlow says, “You’ve always got to be mindful of liquidity. Sub £100m aren’t going to be our main holdings for these reasons,” so capacity does restrict this fund from going after the real minnows of the market.
Given that COVID-19 is what many would describe as a ‘Black Swan’ event, Mr Harlow understandably doesn’t want to be dragged into a discussion of its potential impact on the market, simply because no one really knows at this stage one imagines. However, the way he builds his portfolio is useful in unchartered waters that the markets find themselves in.
“Debt levels are controlled which is good for markets like this where you have really limited earnings visibility. Businesses that aren’t structured sensibly are going to have their covenants called into question, you’re seeing that in the market with mark downs in names like CineWorld. It’s an important starting point for us that balance sheets are strong, we want to see management under promise and over deliver,” Mr Harlow says.
Regarding the sell discipline of the fund, Mr Harlow’s methods seem tried and tested. He’ll sell if there’s a departure from one of the reasons he invested in the company to begin with, or there’s been a material change in direction by the management. Alsoif growth margins under pressure, does the investment case still stand up?
It might be a brave investor who would take a look at small cap stocks in these market conditions but as a market segment, it has outperformed other sections of the FTSE for some time. Furthermore, given the market sell-off there are plenty of buying opportunities although Mr Harlow remains well invested with just a 3 percent cash position. Given the fund’s performance before COVID, it might not be as risky as its name suggests.
AXA Framlington UK Smaller Companies (GB0030310857)
Fund size: £211.40 million
Ongoing fee: 1.59 percent
Ten year annualised returns: 10.64 percent
Top holdings: Speedy Hire, SDL, Hollywood Bowl
