Emma Wall: Hello and welcome to the Morningstar series, "Ask the Expert." I'm Emma Wall and I'm joined today by Morningstar Fund Analyst, Daniel Vaughan.
Hi, Daniel.
Daniel Vaughan: Hello.
Wall: So, we are here today to talk about U.K. smaller companies. There are a number of really interesting players in this sector, but we are going to highlight three that you as Morningstar analyst like today. What's the first fund?
Vaughan: I think we'll talk about the Old Mutual UK Smaller Companies Fund first of all. It's one of the bigger funds in the sector, high-profile fund, a well-known manager. As I've said before, Old Mutual is one of greatest that we like based on the way they hold on to their employees and incentivize well.
Dan Nickols has been there since 2001. He has run this fund for over 10 years, so he is a long-standing U.K. small cap manager. He has proved himself to be a pretty capable manager over the years. He is actually very well supported. He heads a team of six covering small and midcap, so one of the best-resourced teams that we cover and his approach has been pretty consistent over the time he has run the fund.
He is fairly flexible but pragmatic. It's unusual in that it's got a top-down element to it as well as a bottom-up. A lot of small cap managers don't have that kind of top-down macro overlay. He can draw on the highly regarded UK team headed by Richard Buxton to get some macro input on that and they have regular discussions about how they should be tilting the portfolio in terms of sectors, et cetera.
Wall: And to have that decade long experience there is quite important in smaller caps in particular because small caps is a secular asset class. We have had over the last five, six years since the global recession they have gone in and out of favor a couple of times, but now we've got domestic growth in the U.K. and if you're feeling positive about the GDP outlook for the U.K. smaller caps which tend to be more domestically-focused are an area that can do well. So, to have that decade-long experience, to have that big team, it bodes well?
Vaughan: I think this experience has led him down the path of trying to create a more balanced portfolio. He has got a tilt towards domestic cyclicals but he has also got an almost the same kind of way in secular, so long-term growth stories. So, that balanced profile kind of leads towards a more consistent return profile which we like.
Wall: What's the second fund today?
Vaughan: We are going to talk about the Schroder UK Dynamic Smaller Companies Fund run by Paul Marriage. Paul is a pretty experienced smaller cap manager himself. He has got about 12 years.
Wall: Ex-Caz fund of course?
Vaughan: Former Cazenove fund. He joined – he has got some decent support there. John Warren, his co-manager and also analysts supporting them, so plenty of resource there. He has been pretty consistent with his approach. He has got this core of quality sort of market-leading type companies, solid companies but then he will use 20% of the portfolio to go into more shorter-term value type opportunities.
He does tend to favor the micro caps quite a lot. So, it's important that you keep a close tab on how much he is running total so that you can continue to access those kind of micro caps. Last year was an interesting year for the fund. They actually had a lot of inflows. The fund got to $1.3 in size before they then closed it. They saw outflows as a result. It's now back to around $500 million and that's quite a good amount of money in our view to be able to manage the portfolio effectively.
Wall: And did that hurt the fund because smaller caps aren't exactly the most liquid. It's not like he was pulling money in and out of the top 20 in the FTSE 100. This is a difficult style of investment to manage liquidity at the best times when your fund is tripling in size and then a third of the size?
Vaughan: Sure. I mean, in smaller companies, managers tend to like to run their winners but there is a bit more of a temptation to perhaps run those winners longer than you may have done otherwise if you've always got those inflows and a big fund and it gets a bit more problematic recycling ideas. So, yeah, I don't think the flows helped but there were some stock-specific issues as well, some profit warnings among some of his larger positions. So, it was almost a perfect storm for him last year but he has come back very strongly this year. He is amongst the best performers in the peer group. We've kept faith with him and he is looking at a much brighter picture this year.
Wall: What's the third and final fund?
Vaughan: The final fund is Templeton UK Fund, also a very strong performer this year. This is a Leeds-based team of managers who have a collaborative kind of approach. Richard Bullas and Paul Spencer have co-managed this for just over three years now. They have revamped the process when they took it over.
Wall: Really strong team there in Leeds, haven't they, because they have got Colin Morton up there?
Vaughan: Yeah, strong team. I often think there is a bit of an advantage as well to sort of being out of London and in some respects away from the noise, et cetera. It gives you a slightly different perspective on things and I think that Leeds-based team currently has that advantage.
So, I mean, Paul Spencer, a very experienced small and midcap manager and it's his approach that they adopted for the small cap funds. He trained up Richard Bullas. It's a good solid approach. They buy established businesses.
Wall: So, not so much the micro-cap like the one we were talking about earlier? These are sort of – they are smaller companies but they have some names you would have heard of?
Vaughan: Yeah, established business models and the cash generation is pretty key to them and you'll see the average market cap of their portfolio is a bit larger than the Paul Marriage's fund. So, built a nice three-year track record and having a very strong year this year. So, it's coming together nicely.
Wall: Three quite different funds there?
Vaughan: Yeah.
Wall: Daniel, thank you very much.
Vaughan: Pleasure.
Wall: This is Emma Wall for Morningstar. Thank you for watching.
