By actively trimming when valuations get too high and betting on quality cyclicals, one UK equity growth fund has managed to outperform all its peers in a market despite having to navigate Brexit, coronavirus and a major rotation towards value.
The £1.5bn MI Chelverton UK Equity Growth fund is the best performing strategy in the Investment Association’s UK All Companies sector since its launch in in October 2014. It is also the best performer over three and five years.
Perhaps the most impressive fact is that even in the last six months of a major value rotation, the small- and mid-cap focused fund is still ranked top three in the 250-strong peer group, despite operating in a market that has favoured the value trade.
This could be because, although it is a growth-orientated fund, manager James Baker (pictured) is very conscious of the valuations of the high performing stocks in his portfolio.
“We are probably more mindful of value than some fund managers,” he said. “We will try to curate a list of what we think are good quality companies by looking at growth, cash flow and capital intensity.
“But also, when a stock is looking very fairly valued, we are quite happy to take a few chips off the table and bring on a fresh pair of legs because we like to keep the whole portfolio working in our favour.”
While there are plenty of stocks that Baker would really like to add, they are just too expensive for him at the moment.
“We buy them when we think they offer reasonable value,” he said. “They can still be expensive, but relative to their cash generation and their growth prospects, we still find them attractive.”
One reason why MI Chelverton UK Equity Growth’s more recent performance has been strong is because Baker decided to add more “quality cyclical” stocks to the portfolio over the last year ahead of the value rotation.
One example of this was Volution Group, which has been a strong contributor to performance more recently.
Performance of Volution Group over 3yrs
Source: FE Analytics
“Any business making a building materials product which can kind of make an 18 to 20 per cent return on sales, that to us represents a quality business,” Baker explained.
“They’ve got high market share, they’re efficient manufacturers and they have attractive products.
“There's an element of growth in their market because building rates are driving people towards using their products, but it is still a cyclical business because it is exposed in the building industry.”
The fund has owned the company for years, but Baker started adding more shares when it was trading below £2. Fast-forward to today, shares currently trade at just below £4.
Looking ahead, although some of the UK market’s cyclical names have re-rated very positively in the last several months, Baker believes they still have room to run further.
Elsewhere, he is hopeful that the valuations of certain small- and mid-cap tech companies begin to come back a bit, so that he can start adding back to them.
He said: “We will use that opportunity if there’s any weakness in technology to build our holdings again.
“Because if you can provide something that has lots of recurring revenues, is highly cash generative, and has pretty decent growth, then in the long term that is a really good place to be.
“So selectively, we will try and pick up some of these tech names.”
In the last few months, the UK equity market has had mixed results for technology company IPOs (initial public offerings).
Whilst online food delivery platform Deliveroo and cybersecurity firm Darktrace have suffered from weak share price performance after going public, other companies such as Trustpilot and Auction Technology Group have done well after their IPOs.
“There are lots of other interesting quality businesses, but a lot of them have been a bit too expensive for us,” Baker said. “Auction Technology Group and Trustpilot look like very good businesses.
“But if we kill the golden goose with too much issuance of new paper, and the sector de-rates more, then I think that will throw up some interesting opportunities.
“We're not quite there yet but that’s what I'm hoping.”
That is not to say he has not been adding more names to the 168-strong portfolio. Some the latest purchases include small-cap companies like Best of the Best, Wickes Group and Travis Perkins.
Partly due to returns (the strategy is up 60 per cent over one year), but also due to large inflows from investors chasing performance, MI Chelverton UK Equity Growth has almost tripled in size from £600m to £1.5bn.
He admitted that he would prefer if the fund did not any bigger because he does not like taking more than a 5 per cent stake in any single company, which can be difficult in the small-cap universe when running large amounts of money.
“One has to admit that it gets to the size where there are some things which you’d like to do - which would be very additive - but will have a less of an effect on your performance,” he explained.
“We are bit risk averse. We don’t like holding very large percentages of companies.
“We’ll own a reasonably large percent if we are very high conviction, but as a rule we tend to prefer to be a bit more low profile.”
Performance of fund vs sector since launch
Source: FE Analytics
Since launch, MI Chelverton UK Equity Growth has delivered a total return of 284.81 per cent, compared to 137.92 per cent from the IA UK Smaller Companies sector.
The fund has an ongoing charges figure (OCF) of 0.87 per cent and an FE fundinfo Crown Rating of five.