Fund managers are often keen to praise the stocks they hold, spinning a story of future success they hope will come to be associated with the performance of their portfolio in the mind of the reader.
However, Nick Ford, manager of the LF Miton US Opportunities fund, is currently most excited about the stocks he doesn’t own, but are on a shortlist ready to be snapped up when the time is right.
LF Miton US Opportunities is a multi-cap fund that invests in anything from $1bn at the lower end of the scale, while at the upper end it currently holds the world’s second-largest company, Amazon, in its top-10.
Ford said the great thing about this flexibility is that small caps have massively outperformed their larger counterparts over the long term.
So why then does the small-cap weighting in his fund currently stand at less than 1 per cent? The manager said this is due to the cyclicality of small cap outperformance and the current position in that cycle.
“Back in 2015, we dramatically cut the small-cap weighting in favour of the larger area,” he explained.
“What’s exciting now with almost a zero small-cap weighting is at some point, we will be able to pull the trigger when valuations and the risk/reward in small-caps move tremendously in our favour. The fund will be able to show its mettle.
“We say to people we have our best players on the bench waiting to come on, chomping at the bit.
“The exciting thing is that small caps will be on a tear again at some point because they tend to outperform over cycles, typically seven years.
“We’re coming off a very long period of underperformance from small caps. And with this product being a multi-cap fund, it could quickly turn and reposition in favour of small caps, but we just don’t quite think the risk/reward is there yet.”
The risk/reward trade-off is an important factor for Ford (pictured) and his co-manager, Hugh Grieves. The managers said they were given “a blank sheet of paper” when they set up the fund in 2013, and decided to run a style-agnostic strategy that wasn’t tied to a particular index, which means it can make money through different parts of the cycle.
Grieves said this separates LF Miton US Opportunities from most other funds focused on the US.
“We were very much aware that there are plenty of funds in the IA North America sector that do very well for a short period of time, sell an awful lot of units and then crash and burn because they hook on to a particular factor, like growth, value, small-cap or tech, or something that does well for a while and then blows up,” he added.
“We didn’t want to do that, we wanted a fund that could consistently compound returns over time and give clients a steady ride. If some funds are tortoises and some funds are hares, we stick our hands up and proudly say ‘we are a tortoise!’”
The managers begin their process by excluding entire sectors such as biotech (“too binary”), mining (“too unpredictable”) and airlines (“a horrible industry. Pretty much every airline in America has gone bust at least twice”). They then exclude companies that aren’t increasing revenues or converting these into cash.
This results in a list of approximately 400 companies which the managers allocate to according to their analysis of the risk and reward.
“Every day we come in and hit refresh and say, ‘how much further upside is there from here if everything goes right? How much do we lose if it goes wrong?’,” Grieves continued.
“You may have a stock which, if everything goes right, you make 10 per cent, but if something goes wrong, and something can always can go wrong, you lose 30 per cent.
“So, you find another idea where you can make 30 per cent upside. We’re constantly rebalancing and optimising the portfolio.”
Grieves pointed to his experience of holding Worldpay, which handles card and mobile transactions, as a good example of how this strategy works in practice.
The manager said this is a business benefiting from powerful tailwinds – the number of card/mobile transactions is only going to increase – while there are also huge barriers to entry.
This means the only factor that would prevent him from owning the stock is an excessive valuation.
“We originally bought the stock (then called Vantiv) in October 2014, when we paid 31 bucks for it,” he said.
“It was trading on 17x earnings, which we thought was really cheap. That turned out to be really, really cheap. We trimmed it in December 2015 at $52, 26x earnings, then we bought it back in January at $45 and 20x times.
“In March 2016 we sold it at $52, because we needed the capital for another idea. But then three months later, I was in Cincinnati, Ohio and I spent a lot of time with the finance team.
“I came back and said ‘Nick, I’ve made a horrible mistake, we should never have sold that’. So, we bought it back, we paid $1 more than we actually sold it for, but that was fine.”
Data from FE Analytics shows LF Miton US Opportunities has made 158.71 per cent since launch in March 2013 compared with 137.81 per cent from its IA North America sector.
Performance of fund vs sector and index since launch
Source: FE Analytics
While LF Miton US Opportunities does not have a formal benchmark, there is an argument that its performance has been flattered by comparisons with its peers in the IA North America sector, which tend to focus higher up the market cap scale. However, Grieves said that the opposite is true.
“Actually, what you’ve seen since we launched is the S&P 500 is up 120 per cent. And the Russell mid-cap index is up only 80 per cent. So given that we’re a multi-cap fund, we are in line or slightly ahead of the S&P 500. We are ahead of most S&P 500-only funds and way ahead of many small cap funds. So, in the context of that, I think we’ve done well.”
LF Miton US Opportunities has ongoing charges of 0.97 per cent and is £634m in size. The managers plan to soft-close the fund when assets reach $3bn.