Investment: The Fund Manager - The A to B of choosing a profitable portfolio

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The Independent Online
THE INVESTMENT story of 1999 has been, to a large extent, one of smaller companies catching up after underperforming the blue chips for years. This trend has, naturally, benefited those funds concentrating on small-cap portfolios, one of the most highly rated of which is also one of the longest established - Schroder UK Smaller Companies.

The fund is run by Andrew Brough, who developed an interest in investment early. He says: "I have played the market since I was 16, and I've been investing on my own account since. I read economics at Manchester then was an accountant with Price Waterhouse for four and a half years. I joined Schroders as an analyst in 1987, and started heading the smaller companies team 10 years ago."

For that time, he has run an institutional smaller companies fund, taking over responsibility for the retail unit trusts in 1995. He says: "We are looking for companies with a clear competitive advantage which can provide above-average growth over the medium term.

"We try to avoid companies which will probably remain small because they have no competitive advantage or those which have become small because they are operating in declining industries or because they are uncompetitive and badly managed. We pay particular attention to the quality of management.

"The key to our success has been working as a team. There are thousands of small-cap stocks and one person cannot cover them all effectively. Smaller companies continue to be an under-researched area of the market, and this provides good opportunities for fund managers to exploit undervalued shares."

Although Mr Brough is "manager" of the trust, the day-to-day work is shared with Jeremy Smith, a management accountant who has been with Schroders since 1992, and Rosemary Banyard, who started as a private client portfolio manager and equity analyst with James Capel and joined Schroders in November 1997.

"We adopt a very simple ABC strategy," says Mr Brough. "If you imagine a triangle, then on the left side of it are all the `A' stocks. These are companies in a secular growth trend, which means they are in new industries or fast-growing sectors of the economy.

"On the right side are the `C' shares, which are those in secular decline, industries where sales and margins are shrinking, such as textiles or food producers, which have no pricing power. In the middle are the `B' stocks, companies in mature industries with high market share.

The `A' stocks are of most interest to the Schroder team. "Our skill is in getting into the `A' stocks early and getting out before they go ex-growth. We will look at any stock in the FTSE Small Cap Index, but we are heavily overweight in the `A' sectors, information technology, support services or pharmaceuticals, and underweight in the areas in sector decline, such as textiles, property or food producers."

In the portfolio, some sectors included within the FTSE Small Cap Index are not represented. There is no exposure to non-cyclical service companies or utilities and less than 1 per cent in resources companies, three sector groupings make up 32 per cent of the index. The fund is heavily underweight in financials (10.4 per cent compared to an index weighting of 25.5 per cent).

Conversely, the fund is heavily overweight in cyclical service companies (just under 40 per cent compared with an index weighting of 15 per cent) and also has significantly higher proportions of stocks in basic industries and general industries than the index. This is also largely reflected in the fund's largest holdings - Photo-Me International (media & photography) at 3.03 per cent of the portfolio, Trafficmaster (transport) 2.37 per cent, Goldshield Group (pharmaceuticals) 2.32 per cent, Whatman (engineering & machinery) 1.92 per cent and Helphire Group (speciality & other finance) 1.82 per cent. Mr Brough says: "Some holdings delivered excellent long- term growth and are still in the portfolio after several years - Photo- Me is a good example. The basis of our success over the past five years was setting ourselves the target of outperforming the Small Cap Index, and the All Share. Now we are going to take that philosophy on to the mid-cap team."

Schroders is launching a UK Mid 250, to be run by a team led by Mr Brough, which will apply a similar philosophy to a portfolio of mid-cap stocks. The most successful smaller companies tend to become mid-caps sooner rather than later - Photo-Me International and Trafficmaster, for example, are already well-established within the FTSE 250 Index and both have shown exceptional performance this year.

Mr Brough says: "Medium-sized companies, just like smaller stocks, offer investors exposure to some of the most dynamic and fastest growing companies in the UK. Medium- sized companies are also surprisingly under-researched. Most investment analysts focus on the largest FTSE 100 companies, even though the FTSE 250 represents 15 per cent of the market by value.

"Photo-Me and Trafficmaster may be followed by two analysts but Glaxo Wellcome or SmithKline Beecham may hire a hall for their results meetings so all the analysts and investment specialists who follow them can attend. As a result, many opportunities provided FTSE 250 companies may be missed. The situation is even more pronounced among the small caps.

Fundamental Facts

Fund Manager: Andrew Brough

Age: 39

Fund: Schroder UK Smaller Companies

Size of Fund: pounds 310.11m

Fund Launched: 23/05/1979

Manager of Fund: Since 1995

Current Yield: 0.41%

Initial Charge: 5.25%

(Investors may buy at significantly lower cost via a discount broker)

Annual Charge: 1.50%

Current Bid/Offer Spread: 6.25%

Minimum Investment: pounds 1,000 (subsequently pounds 500)

Min Monthly Saving: pounds 50

Standard & Poors' Micropal Rating (maximum KKKKK): KKKKK

Fund performance (to 1 October 1999):

One Year 31.21%

Two Years 31.87%

Three Years 47.88%

Five Years 136.33%

Seven Years 262.44%

Ten Years 179.93%