25 March 2022
By Scott McKenzie, Fund Manager, Amati UK Smaller Companies Team
Over the past three years we have seen unprecedented changes in market leadership as investors have tussled with the impact of Brexit, COVID-19, the re-emergence of global inflationary pressures and, more recently, the potentially significant long-term implications of the Russian invasion of Ukraine. There is much ongoing debate about style rotation and which style tilts will prove to be a winning investment strategy moving forward. Whilst there is always a temptation to pigeonhole businesses into “value” or “growth” buckets, in reality the world is considerably more nuanced than this, and indeed many businesses have found themselves categorised with both labels over time as they develop. At Amati we would summarise our process as investing in high quality businesses with enduring growth potential. As a result, over many years the TB Amati UK Smaller Companies Fund has tended to show a bias towards growth & quality factors, with a correspondingly lower exposure to value measures. The analysis below from Style Analytics highlights the current key tilts in the portfolio compared to our Numis NSCI & AIM benchmark.
Portfolio Style Factors
Source: Style Analytics , 28.2.22
Whilst global level growth strategies have significantly outperformed value strategies for over a decade now, in our universe of UK smaller companies, value factors have enjoyed a strong return to form more recently. The chart below shows the performance of the MSCI UK Small Cap index in terms of its value and growth components over the past three years.
UK SmallCap – Value Catching Growth
Source: Liberum, MSCI, 28.2.22
We can see from this chart that the strong post COVID outperformance of growth factors peaked in late 2020 at which point the rollout of vaccines began. Since then, value has been in the ascendancy. As inflation surged and interest rate expectations rose during the latter part of 2021, we saw a further leg down in longer duration, higher growth assets. In many cases valuations had been driven up to unsustainable levels. This trend has continued into 2022 and has been exacerbated by recent tragic events in Ukraine, with deep value and out of favour resource sectors performing strongly as commodity prices across energy, metals and agricultural products rose sharply in response to the crisis. As a result, over the past three years we have seen the performance of value factors in UK smaller companies level up completely with growth factors.
This comes against a background of falling valuations across the small cap universe in general and a period of relative underperformance against larger cap indices such as the FTSE100. The analysis below looks at PE ratios across various market capitalisations in UK listed companies. Having enjoyed a premium in recent years smaller companies have recently reverted to trading on a discount again.
Source: Liberum, Datastream
This dramatic change in market leadership away from small caps and towards value factors has led to a material derating of many quality growth companies, and the TB Amati UK Smaller Companies fund has not been immune to this shift. The slide below covers various current valuation metrics for the Fund and compares it to the readings six months ago. We have also included the Quest UK SMID metrics for reference as a proxy for our investment universe.
Portfolio Valuation Metrics
Source: Canaccord Quest, Amati Global Investors
As highlighted previously, the Fund typically has a bias towards growth factors, and therefore we would expect to see slightly higher levels of PE ratio, EV/Sales and Price to Book metrics compared to the SMID universe. However, all these measures of valuation for the Fund today are significantly below the levels seen six months ago. We also take comfort from the solid dividend and cashflow readings and would highlight other key quality factors such as the very low levels of debt (net cash) and high profit margins in the portfolio. This is consistent with the style profile of the Fund over many years, and we would re-iterate that the portfolio today remains overweight growth and quality factors whilst being underweight value. Our process has not changed.
The results above clearly demonstrate the reduction in absolute valuation metrics over the past six months but also reflect a more difficult period for our returns in general. Our recent portfolio activity has focussed on ensuring that we reduce valuation risk through selective stock sales whilst maintaining our long-term commitment to owning high quality businesses. Given the rapid derating of many quality growth companies of late, we have been taking the opportunity to increase our weightings to some of our favoured stocks as well as introducing some new names to the fund.
This focus on quality is worth emphasising again as these factors tend to be less volatile and more durable than the more random and shifting classifications of growth and value. At Amati we view high quality at the portfolio level as a sacrosanct part of our proposition. The chart below looks at the cumulative performance of the highest quintile quality small cap businesses, as measured by the Quest database over the past twenty years.
UK SmallCap – Quality Endures
Source: Canaccord Quest
The message is clear - over the long term, exposure to the highest quality businesses is a consistently positive factor in delivering strong performance in UK smaller companies. The TB Amati UK Smaller Companies fund has certainly had some headwinds to contend with over the past twelve months or so, but we are increasingly optimistic about the prospects for the portfolio looking forward. Faced with a highly challenging and ever-changing macro environment we are confident that our ongoing focus on selecting high quality growth companies will deliver strong returns for our investors over the medium and long term.
This article is a financial promotion issued by Amati Global Investors Limited, which is authorised and regulated by the Financial Conduct Authority. It is provided for informational purposes only and does not represent an offer or solicitation to buy or sell any securities, and nor does it provide you with all the facts that you need to make an informed decision about the merits or otherwise of this Fund. Please refer to the risk warning below.
Past performance is not a reliable guide to future performance. The value of investments and the income from them may go down as well as up and investors may not get back the amount they originally invested. Investments in smaller companies in particular can be higher risk than investment in more established blue-chip companies. Prospective investors should always read the relevant fund or product documentation, which contains full details of the costs and charges as well as specific risk warnings.
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