The recent correction in UK small-caps has given Cavendish Asset Management’s Paul Mumford a reason to smile again and the opportunity to pick up his favourite stocks at lower valuations.
Mumford, who manages the five FE Crown-rated TM Cavendish AIM fund, said negative sentiment and a recent sell-off in markets had allowed him to add three new positions to his portfolio.
“On the one hand you find funds have had redemptions and therefor they will sell what they can,” said Mumford. “Consequently, the decent stocks get knocked back with the rubbish and that gives you an opportunity to find the gems in the market.
“More recently, we’ve found that some funds have actually been forced sellers of shares. I don’t know why: they’ve either had really big liquidations or they’re illiquid funds, or they’ve got to sell something, or they’re funds that are being wound up.”
As such, the manager has been able to snap up shares at a discount to the market valuation.
“In other instances, you’ve had demand for some fairly illiquid stocks and we’ve been able to recycle the money,” the manager added.
Having beaten the FTSE AIM All-Share index in each of the past five calendar years and the sector in four, TM Cavendish AIM is currently outperforming again in 2018.
Since the start of the year the fund has fallen by 0.93 per cent, although this compares well with a 7.15 per cent loss for the average IA UK Smaller Companies member and a 10.86 per cent fall for the benchmark FTSE AIM All-Share index.
Performance of fund vs sector & benchmark YTD
Source: FE Analytics
The manager said he has been helped by positive developments at some of his largest holdings, where share prices are “beginning to shoot the lights out”.
“It’s actually been a little bit better than it actually looks: what I’m quite pleased about is the positioning moving forward, forgetting that it’s performed quite well in the current year,” explained Mumford.
One area that the manager is more bullish about is oil, where he said there is a “huge amount of potential”.
Although prices have fallen back somewhat more recently – with the Bloomberg Brent Crude Sub index down by 13.79 per cent in US dollar terms – Mumford remains confident that “sensible management” will have led most companies to hedge their forward oil sales at higher prices.
Performance of Bloomberg Brent crude sub over 3yrs
Source: FE Analytics
“Where they have hedged at $70 per barrel or more, it’s going to produce a very good cash flow for the current year and see us through a rocky period,” he said.
Mumford said that investors who have previously shunned the sector because of concerns over leverage may find that they have stronger balance sheets than anticipated.
Additionally, some oil stocks may find themselves as the subject of takeovers, although that might not necessarily please the manager of the TM Cavendish AIM fund.
“Oil majors have still got this problem of having to kick back into investment, having not been there for a long time,” he said. “Takeover activity is something I would be disappointed about if companies were taken over at anywhere near current levels.
“We’ve seen it in the past where medium-sized oil companies have been taken out because it was cheaper to buy a company than it is to drill.”
He added: “There are a lot of really interesting companies at the lower-end of the spectrum, below institutional shareholders’ market caps, and are essentially ‘10 baggers’ in the marketplace.”
A number of the fund’s investments are related to the oil sector including the top holding infrastructure company RockRose Energy at (6.3 per cent), North Sea oil & gas firm Serica Energy (2.6 per cent), and exploration company IGas Energy (2.6 per cent).
While some international investors have become wary of UK stocks as the government presses ahead with plans to exit the EU next March, Mumford believes there are still plenty of positive signs for companies at the lower end of the market-cap scale.
The Cavendish fund manager said that the government remains supportive of smaller businesses and hasn’t made any changes to tax policies that encourage investment in the sector.
“We’ve had a lot of IPO [initial public offering] activity in recent weeks and the incentive is there [for companies] to come to market and for investors to invest, which I think must be good for the whole economy,” he explained.
As such, the manager remains positive about the outlook from smaller companies particularly at the more attractive valuations they are currently trading at.
“I love it. I much prefer these conditions when markets are racing ahead and everybody is bullish and your ratings are sky high; that’s when you start worrying,” the manager said.
“If you look at the situation in America where your Apples and Facebooks of this world got to such fancy valuations and nine months or a year ago people said these things are never going to come back.
“Inevitably there will be a correction and we’ve seen that lately in the US market.”
He concluded: “I’m not saying where in a bear market – I think we’re in a bit of a correction – but it does give you great opportunities from a stockpicking point of view and it’s a very exciting time.”
Mumford has managed TM Cavendish AIM since launch in 2005 and also manages its £144.7m sister fund, TM Cavendish Opportunities.
Performance of fund vs sector & benchmark since launch
Source: FE Analytics
Since launch in October 2005, TM Cavendish AIM has delivered a total return of 197.71 per cent compared with a loss of 1.19 per cent for the benchmark and a 214.02 per cent gain for the average peer group average.
The fund has an ongoing charges figure (OCF) of 0.84 per cent.