ndate, so we feel the resources might be spread a bit thin here.
Although we would usually be concerned that shareholders are losing an experienced manager in Iain McCombie, Brodie has worked with McCombie as a small-cap analyst for the past seven years, so he's well versed in the research process. Moreover, he will use the same strategy as McCombie, with a continued emphasis on companies that can deliver sustainable earnings growth over flashier speculative fare. To identify such firms, Brodie looks at a company’s ability to generate free cash flow, solid working capital and manageable levels of debt to ensure the company can stay afloat in the long-term. The manager isn’t value driven, but he does look for reasonable valuations, giving the fund a slight value tilt.
Those criteria have led McCombie and now Brodie to keep the portfolio underweight its average Morningstar UK Small-Cap Equity category peer in sectors where stocks have become pricey, such as industrial materials and energy. For the same reasons, the portfolio has been overweight the category average in financial services – a position which hurt this fund during the summer due to the credit crunch. For example, the holding in Brewin Dolphin, the private client investment manager, lost around 14% from mid-July to mid-August 2007.
The fund’s recovery thus far has been stuttering. Although for the year-to-date the fund has outperformed its average category peer by 2.1 percentage points, this is due solely to a large margin of outperformance in February 2008. However, we believe the strategy’s focus on strong free cash flows and sustainable growth at a reasonable price is sound and has the potential to deliver strong results over the longer term. We need to see more of Brodie's ability to execute, but given the continuity of process and the fact that McCombie remains at the firm and available for Brodie to use as a resource, we believe the fund should remain a solid holding in the Morningstar UK Small-Cap Equity category.
