An industrial revolution kick-started in the early 1970s is continuing to have a major impact in the UK small-cap market, according to Amati Global Investors’ Paul Jourdan.
With a greater potential for significant upside than their large-cap peers, smaller companies operating in more niche growth areas of the market can often seem an attractive proposition for long-term investors.
Jourdan, co-founder of Amati Global Investors and a manager of TB Amati UK Smaller Companies, said that he and his team’s bottom-up stockpicking strategy focuses on high-quality businesses with the best growth outlooks.
“We have a sense that if you can find an opportunity to invest early on in a high-quality growth business, there are very few investments you can make that will be anywhere as good as that,” the manager said.
“The beauty of that type of investment is that you can hang on to it for a long time and it will carry on doing for well you.”
He added: “They are hard to find and there are inflection points when they stop doing well for you, but – in essence – that is the core of what we do.”
As such, TB Amati UK Smaller Companies’ focus on high-quality businesses has led it to identify a long-running theme in the small-cap space that has driven some of its best performers.
The FE Alpha Manager said there was a reason that his five FE Crown-rated fund has outperformed the index and its peers over the past decade.
Performance of fund vs sector & benchmark over 10yrs
Source: FE Analytics
Indeed, the TB Amati UK Smaller Companies fund has made a total return of 583.51 per cent over the past 10 years compared with a 333.91 per cent gain for the average IA UK Smaller Companies peer and a 275.93 per cent rise for the Numis Smaller Companies + AIM Excluding Investment Companies index.
“I think it has been possible to do because we have been in a particular phase of an industrial revolution, based around digital technology,” said Jourdan. “It’s a relatively late part of that revolution: it goes back to 1972 and the invention of the microprocessor.”
Jourdan said the possibilities presented by the microprocessor were not realised until the early part of the 21st century although, even then, it was still too early to reap the benefits of such a technological advance.
“It was premature because we could imagine what would happen, but we didn’t know how long it was going to take to get there and it always takes longer than you think,” said the fund manager. “But 10 years and a couple of financial crises later we enter what I would call an ‘implementation phase’ of this revolution.”
Highlighting economist Carlota Perez and her work on industrial revolutions past and present, Jourdan said the implementation phase is usually characterised by technologies mature enough to make commercial gains and material enough to make a massive difference in industry.
As such there are “real winners and losers” based on those who are at the front of the implementation phase and those that haven’t caught up at all.
“A lot of the companies that we look at and like are those which are able to deploy digital technology more effectively in a particular industrial niche, where there is a clear opportunity and real domain expertise in the management team,” said Jourdan.
And one of the best places to find those companies is in the UK, said the TB Amati UK Smaller Companies co-manager where there are very experienced management with strong technical capability and an opportunity to exploit.
The emergence of several very large players in the technology sector has changed the space somewhat, according to Jourdan, given the large amounts of cash that they generate that allows them to buy any company they find interesting.
“Where we’ve seen opportunities that remain – notwithstanding that phenomenon – is a very specific niche which is too small for Google or Facebook to be interested,” he said. “In those niches I think there are still good opportunities.”
The FE Manager added: “There are other kinds of companies where they have such a strong position that they can actually keep the bigger companies out.”
Performance of stocks over 3yrs
Source: FE Analytics
Two companies that with dominant positions in their respective markets are Rightmove and Auto Trader, both of which occupy what the Amati team consider ‘prime real estate’ on the internet.
“It’s prime real estate because it can’t be replicated and there’s not very much of it,” said Jourdan. “Where you have prime real estate on the internet it tends to mean you have an unregulated monopoly.”
However, the manager said there is a danger that such companies exploit those positions too hard and distance themselves from their customer base, forcing them to seek out alternatives.
“We made a switch last year from Rightmove to Auto Trader and we did that because we felt Auto Trader had a roadmap that was going allow them to add lots of value to their customers over the next five years,” he said.
“And that protected them against cheesing their customers off too much given that they put their prices up every year.”
One example of when it can go wrong is funeral services provider Dignity, one of the dominant players in that market.
“They put their prices up every year and what that eventually did was make it very easy for competition to come in and undercut them,” Jourdan said, adding that the company had undermined its own position.
“The competitive fightback has been pretty strong and they’ve had to cut prices by 25 per cent on certain funerals.
He added: “It’s the one thing that people very rarely shop around for: you have other things to worry about when you’re in that position. But nonetheless they paid the price for pushing too hard on their prices for too long.”
Performance of fund vs sector & benchmark under Jourdan
Source: FE Analytics
Jourdan has managed the TB Amati UK Smaller Companies fund since 2000 during which time it has delivered a 591.16 per cent total return compared with a 251.2 per cent gain for the peer group and a 184.4 per cent return for the benchmark.
He is joined on the fund by David Stevenson – a co-manager since 2012 – and Anna Wilson, who was appointed co-manager last year.
The fund has an ongoing charges figure (OCF) of 0.94 per cent.