Given that the macro conditions of the current black swan market are changing almost by the hour, Amati fund manager David Stevenson tells Fundeye what his team are looking for among their 67 holdings in its UK Smaller Companies fund.
“The key thing for us is that you don’t want to be in companies whose revenues are dependent on discretionary spending behaviour, things that are non-essential, which can be true of domestic and international firms and you certainly don’t want that linked up with a heavy dependence on debt, operational gearing, where a small change in the top line makes a big difference to the profits,” he said.
Concerns that had been top priority prior to the COVID -19 outbreak such as currency exposure now don’t seem as important as the sheer ability to survive in this environment.
One aspect of portfolio construction that any small cap manager has to be aware of is capacity issues, although this is not particularly concerning to Mr Stevenson. Prior to COVID, the fund had assets around £435 million, as with the entire market, the fund has seen some of this wiped off but he sees the fund having the capability to at least double in size.
The universe of companies the team can look at has been shrunk down to around 1000 as the market capstarting point is £100 million, although it should be noted that at the core of Amati’s business is AIM VCTs, which the firm merged into one so has great experience in the small cap space.
With a forward price-to-earnings ratio over 15-times at the portfolio level, this is higher than the benchmark and ensures that growth is embedded in the stocks selected. However, in the current market some companies, even those favoured by Mr Stevenson’s small cap manager peers, have been taken out of the portfolio despite, at face value, looking like good companies.
One example is Hollywood Bowl, a firm that has enjoyed fantastic growth in recent times. However, it falls into the aforementioned discretionary spend category and Mr Stevenson notes that while other types of discretionary spend may just be put off until this situation is resolved, such as purchasing a sofa for instance, a night’s bowling abandoned is revenue permanently lost. Furthermore, he points out whether this sort of activity will even be permitted and also the real health concerns of people putting their fingers into shared bowling balls, a potential breeding ground for COVID.
In terms of the metrics Mr Stevenson looks at, net debt to EBITDA levels of between one to a maximum of two times are preferred although certain sectors get given a bit more scope for debt levels. An obvious one would be property companies, which by their nature are more heavily geared. This is tolerable though as he points out that revenues are contracted in the form of tenants paying rents, even better if these are government or corporate sourced.
The types of companies that Mr Stevenson and his team like are asset lite firms, for instance GB Group, which provides credit checks and similar background information to corporates. Its top holding OneSavings Bank has been the darling of the challenger banks, a firm favourite of Investec’s banking analyst Ian Gordon.
While this fund may have the desire to double in size from its current £390 million, currently the firm is not courting the large institutional fund buyers for reasons mentioned above, namely capacity. Mr Stevenson is not ruling out getting these players involved at some point but he’s keen to avoid “style drift into a mid-cap fund just because the fund gets bigger”.
Being a growth fund, the Amati team looks at a variety of metrics in addition to ones already mentioned, even what Mr Stevenson describes as the ‘crude’ price-to-earnings growth (PEG) marker. Given these uncertain times, investors in Amati's funds may be heartened to hear that the firm itself is 51 percent owned by the employees, so all the managers have skin in the game. With a ten year annualised return rate almost double its benchmark at 12.17 percent, this fund seems robust and able to weather what is looking to be one hell of a storm.
*David Stevenson is not the author of this piece, he is a fund manager at Amati
