MAY 2012 Tracking lost opportunities
Unicorn has one of the largest teams in the market and its intensive research is allowing it to find fresh, quality opportunities in areas that other firms might easily miss out on.
JOHN MCCLURE Co-founder, senior fund manager,
It is widely acknowledged that the Retail Distribution Review is creating a broader market for those fund manage- ment groups that are focused on alpha- generation. Stock-picking in its purest sense has been Unicorn’s focus since its launch in 2000. For a small company, it has built ample resources to support its detailed, conviction-led process and this has produced strong long-term perfor- mance across its fund range.
Unicorn’s six fund managers work closely together, share ideas and hold a common philosophy. John McClure, manager of the UK Income Fund, says: “We are all trying to uncover companies that are profitable and likely to grow over the next five to 10 years. We don’t expect a stock to be a one-trick pony, and that each stock will go up 100%. We’re not always looking for the next Microsoft, but we want incremental, year-in, year-out dependable growth.” At the heart of the group’s investment philosophy is the desire to seek out the quality opportunities missed by the mar- kets. McClure says: “We’re often looking at the things that others can’t look at because of their size, where the com- pound growth might be significant. Because of our relatively small size, we can take positions other companies can- not.” However, there is also a focus on quality and on areas such as balance sheet strength and cash flow, hence the avoidance of banks. The managers will avoid non-profitable technology stocks and those areas vulnerable to the whimsy of commodity markets such as mining or oil and gas exploration. The majority of the research work is carried out by the fund managers, rather than an in-house research team or by calling upon broker research. Although, as might be expected from specialist stock-pickers, the Unicorn managers tend to find many opportunities in the mid and small cap area, it is by no means its only focus and the group offers a broad spectrum of equity funds, each adapting the central process to their indi- vidual mandates.
For example, the UK Equity Income Fund, run by John McClure, focuses on
dividend payers, the Outstanding British Companies Fund, draws out the best companies operating within the UK, while the Free Spirit Fund, co managed by McClure and Fraser Mackersie has a broader thematic mandate which cur- rently incorporates a significant weight- ing in technology and innovative companies. The Mastertrust Fund is a multi-asset fund of investment trusts run by Peter Walls, while the UK Smaller Companies Fund is a pure smaller com- panies play. The group also runs the largest specialist AIM VCT. The group has built its history and reputation on uncovering the strongest opportunities from all listed securities irrespective of their market capitalisation.
Doing all the research in-house is labour intensive and this is where the team’s size relative to its asset base is a key strength: “We believe that it takes more than just one individual to manage significant assets with a stock-picking approach. Fund managers need suffi- cient support,” says McClure. “Sir Edmund Hillary needed Sherpa Tenzing Norgay to get to Everest and we believe investing can be similar at times. We have 1000-2000 companies from which to choose and on many of them, there is relatively little research.” Meeting management is an impor- tant part of the overall Unicorn philoso- phy and the managers will see company directors regularly. Many of the compa- nies within the group’s portfolios will have been known to the managers for a number of years and they will therefore be familiar with the management team. They will be judging whether they are keeping to their long-term plan and whether they are optimistic or pes- simistic. Any deviation from an estab- lished business plan would be a red flag. The Unicorn process is rigorously applied across all funds and fine-tuned by individual fund managers to accommo- date their respective mandates. However before the inclusion or exclusion of a stock the manager’s recommendation is subject to the scrutiny of the investment team. Our committed approach to stock selection results in focused portfolios of 30-50 holdings which directs that each fund looks quite different from the benchmark weighting.
There is a natural value bias to the Unicorn style. McClure says we tend to prefer to buy good companies when they have been over-looked and when we believe that they are likely to come back
into favour. For example, for the Income Fund, he will look at companies paying a dividend of 5-5.5% that are ‘unfashion- able’ for whatever reason.
However, “unfashionable”does not mean risky. The group is not looking for companies with signs of distress. The stocks in which they invest tend to have relatively little debt with strong balance sheets. The managers would usually sell out over a change in strategy or if valua- tions moved too high. For example, the Income Fund held Weir group for a long time, upon entering the FTSE 100 its val- uation rose substantially. McClure is always valuation-conscious and there- fore sold his holding.
Other risk management strategies within the process include a sanity check on sector exposure. Across the board, the fund managers at the group are con- scious of managing liquidity, particu- larly at the smaller end of the market capitalisation range. The funds’ average market capitalisation is more than suffi- cient to manage the day to day fund flows, adding more often than not to existing holdings.
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We’re often looking at the things that others can’t look at
because of their size, where the compound growth might be significant. Because of our relatively small size, we can take
positions other companies cannot
The funds have seen strong perfor- mance across the board, performing par- ticularly well in the markets of 2009 and 2010 and to date in 2012. The UK Income, Outstanding British Companies and Free Spirit funds are all top quartile per- formers over one, three and five years. The Unicorn team have a blend of dif- ferent backgrounds. McClure points out that two of the team are from accoun- tancy backgrounds, while he has been a fund manager for over 25 years, special- ising for most of his career in smaller companies. He believes the blend of skills makes for healthy discussion and the range of perspectives contributes to the overall performance of the funds. McClure believes that the ownership of the organisation is key to the lengthy tenure of all the fund managers. He says: “The managers own the business and aren’t inclined to work anywhere else. This creates real continuity. Unless all the managers agree, we can’t be taken over. It also means that we aren’t going to suddenly change our investment style.” The post-RDR environment for fund management is likely to see an increased focus on genuine alpha generation, which will favour those doing the hard work to uncover value not yet recognised by the market. It is an environment that should suit dedicated managers such as Unicorn.
FUND PROFILE
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