Buying smaller companies or newly listed businesses comes with inherent risk, but if it is done well it can lead to significant reward.
This strategy has been adopted by the Octopus UK Micro Cap Growth fund with success over its 15 years, with the portfolio beating its benchmark and average UK small-cap peer since launch, up 279.1%.
FE fundinfo Alpha Manager Richard Power has a good track record of picking winners. He invested early in tonic maker Fever-Tree, buying in at launch in 2014. Since, the stock has gone on to make 1,165%.
Performance of fund vs sector and benchmark since launch
Source: FE Analytics
The stock is no longer in the fund, but there are others that he has equally high expectations for. “You hope to find one company like that a year really,” Power said.
Recently, he has pinpointed Future, the magazine publisher, as one that can replicate the success he had with Fever-Tree.
Below he tells Trustnet why, and also explains how running venture capital trusts (VCTS) improves the stock picking on his public strategies.
What is your stock picking process?
It's a long-term approach of investing in small companies that are progressive in nature and have the opportunity to become substantially larger than they are at the point of investment, hopefully becoming relevant on a global scale.
We do not limit the size a company can grow to before we sell it. We have stocks in the fund that are £2bn today such as RWS Holdings, which was £65m when we first invested, but we are holding it because we still think it can double in size over the next five years or so.
We have a core-satellite split, the latter is where any new holdings go before they go into the ‘core section’ and makes up at a maximum 25% of the fund. The main part is full of established leaders and high-quality businesses.
Why should investors pick your fund?
We are differentiated by the fact that it is a micro-cap fund, so we are trying to capture these opportunities at an even earlier stage, before they are on the radar of the broader investment community.
We can also seed investment opportunities better via the VCTs we run. We have eyeballs on all of the companies raising money or looking to list at sub £20-£30m, and we have a rule that we look at everything. So we can watch how the companies develop in the VCTs and then pluck out the best opportunities and put them in the micro-cap fund once we’ve got confidence that they're on that growth trajectory.
What were the best and worst performers last year?
The best performer was Next Fifteen Communications, a media business which had around four or five earnings upgrades during the year. It has had a tremendous year and shares rose 157%, which contributed 2.3% to the fund’s performance.
The biggest faller was IG Design which was down 59.7%, a 0.98% detraction on last year’s returns.
There was a common theme among our detractors last year, IG Design, Joules and In The Style and it was something we got wrong. They were businesses which had more complicated supply chains and short-term cost increases because of inflation.
How does a holding like In The Style work within Octopus’ ESG commitments?
As a business they would be very disappointed to be put in the ‘fast fashion’ category with the likes of ASOS or Boohoo. They would claim that their inclusion and supply chain management is streets ahead of the wider sector and we got a strong sense that this was very much a part of the company’s DNA when we met the founders and initially invested.
It is not about sourcing for the cheapest price, it is about ethically sourced materials and products. When it came to market it set out to do something better. If companies are setting out to make things better I think that's a good starting point.
What is the most exciting stock in the fund?
Future PLC is very much on the steep upgrade Fever-Tree was on when we held it in the fund.
It has been a great contributor to performance over the past two or three years. It was around £66m when we invested and after a turnaround with the management team it is now up to £4bn, but it is still in the fund because we still think it has the potential to grow into a truly global business.
Why do IPOs go wrong?
Valuation is absolutely key. The worst thing a company can do, but it is the most common mistake, is to think that to be successful you have to come to market with as high a valuation as possible.
This often makes forecasts quite stretched, hitting companies with a double whammy of missing the forecast and then having to pull back from the high rating.
It is easier said than done and I think a lot of companies that IPOed last year got unstuck by this. It was a very, very difficult year to come to market because there were years of completely different trading environments back to back and changing consumer behaviours. They, in goodwill, thought that they had some consistent data showing some consumer behaviours, which turned out to reverse once things reopened.
What do you like to do outside of fund management?
My two children take up most of my time but I love skiing, that is a big passion of mine. I’m excited to take them skiing for the first time soon. Horse racing has been an interest of mine since I was a boy, but more the breeding end which I have gotten involved with in recent years. And it is a passion my wife loves as well.