Main changes to the fund

We started a new holding in Alpha Group, a foreign exchange specialist. It is growing rapidly (few companies have delivered stronger earnings growth over the past few years), it is financially robust (it is expected to end the year with around £200 million net cash on its balance sheet), it is cash generative and should be a beneficiary of higher interest rates.

We also started a new holding in FDM, a recruitment consultant. It has a strong balance sheet and an excellent long-term growth record. A third key addition was Tatton Asset Management. We are attracted by the growth in platform-only discretionary fund management.

We funded these additions by trimming some of our stronger performers including Medica, MoneySupermarket and Dunelm. We also trimmed Mears, whose strong performance had taken the holding above 3% of the fund. We sold out of RPS as its takeover by Tetra Tech (at a 90% premium to the pre-bid share price) completed. Similarly, we sold our holding in Crestchic after the bid from Aggreko completed (at a 44% premium) and Euromoney after a private equity bid completed (at a 34% premium).

Explaining the fund’s performance

The fund fell by 3.9% over the reporting period versus a fall of 4.5% in the median fund in its peer group and a gain of 1.4% in the benchmark Numis Smaller Companies (ex-IT) index,¹.

It was a period in which ‘what we don’t own’ was a significant factor in the fund’s underperformance relative to the index: Carnival (up 124%) and Aston Martin (up 130%) both bounced strongly from earlier weakness but aren’t held in the fund.

The single biggest negative for our relative returns, however, was RWS, which came under pressure (down 35%) as it indicated that its profits would be towards the lower end of expectations. Jadestone Energy also fell. Although it recently resumed production at its Montara oil field (a positive) its auditors required it to issue new shares to replace the cash lost whilst it was offline.

Set against those negatives, Mears, our largest holding, reported that it “expects full-year profits to be materially ahead of current market expectations.” Its shares ended the period 40% higher. Also on the plus side, we saw strong performances from Jet2, Dunelm, Moonpig and Halfords.

The wider context

The fund has now received 25 recommended takeover bids for its holdings since 2019 and nine since the start of 2022. We see these bids as third-party validation of the value we can see in our holdings.

Looking ahead

UK equities – including the shares of smaller companies – remain deeply out of favour. In our view, this is creating a buying opportunity. The UK economy is proving far more resilient than had been widely expected. Six months ago, the Bank of England was forecasting one of the deepest and the longest recessions in history. It is now forecasting that there will in fact, be no recession at all in 2023. Instead, it now sees real GDP growing from here.

Despite this improving economic backdrop, UK equities – including smaller companies – remain unusually cheap relative to companies in other regions. This reinforces our view that this is a great buying opportunity as small caps continue to price in a recession that we increasingly feel is unlikely.