Mark Dampier: Downing's approach could be up your street
Saturday 08 September 2012
For many investors Downing won't be a familiar name, even though it has been established for over 25 years and has over £300m under management. This is because it primarily specialises in tax-efficient products such as venture capital trusts and enterprise investment schemes.
However, in February last year it took over a tiny unit trust, restructuring it to its style of investment. It has resulted in an exciting, focused portfolio of approximately 25 smaller-company stocks.
The fund remains very small at £3m in size. However, this is actually a distinct advantage. The fund looks to invest in AiM and other small-company stocks capitalised at under £150m. It would be difficult for large funds to take meaningful positions in such companies as they wouldn't be able to secure enough shares.
In this microcap space there are many excellent companies. They are generally poorly researched by the analyst community and there is insufficient liquidity in the shares to generate any real interest. These anomalies can create excellent long-term buying opportunities for those willing to put the time and effort into finding the best ones.
Judith MacKenzie, the fund manager, takes a private equity-style approach to investing. Ms MacKenzie often aims to buy large enough stakes to effect change in the underlying company. This could be to encourage merger or acquisition, help management restructure, or provide strategic advice. Her philosophy is to spend a lot of time looking at the various operations of the company, speaking to middle and senior management.
Ms MacKenzie looks for management with "skin in the game", meaning their interests are aligned with shareholders'. Rather than share options, which could incentivise them to be overly aggressive as there is no downside, management should hold sizeable portions of equity. The Downing team are used to analysing small businesses through their experience of venture capital trusts. It also means they have built up a wealth of experience and contacts in an area which is under-researched. Many companies do not even have a dedicated broker or adviser. It is therefore an area where hard work can uncover some real gems.
One success story has been Tracsis, which came to the market in 2007. The company, spun out of the University of Leeds, specialises in transport scheduling software. Devising train timetables may not sound very exciting, but there is a growing market for the company's products and it has had eight profit upgrades since April this year.
As with all private equity-type investments, a five-year-plus time horizon is needed for this fund. Performance is likely to be erratic as the concentrated portfolio means each stock, especially the largest, makes a real difference to returns. It's an area where passive fund management doesn't work. It is labour intensive, and insightful managers able to put in some hard graft have a great chance to outperform.
Probably the most well-known fund in the microcap space is Marlborough UK Micro Cap Growth run by the well-regarded Giles Hargreave. It will be interesting to see how Downing's approach compares with this. Ms MacKenzie has the advantage of size, with her fund at £3m and Marlborough UK Micro Cap Growth at over £200m. I like the management on both funds but the small size may just give Downing an edge. Clearly the risks with this type of fund are very high, but for more adventurous investors it could add some spice to a portfolio.
Mark Dampier is head of research at Hargreaves Lansdown, the asset manager, financial advisor and stockbroker. For more details about the funds included in this column, visit www.hl.co.uk/independent
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