Fund Focus: four small-cap winners making big bets

There’s plenty of cheer to be had for UK investors. 

The FTSE 100 has continued its strong run - and importantly continues to offer some diversification versus markets dominated by the artificial intelligence (AI) theme.

Perhaps more encouragingly, it’s no longer just the biggest UK-listed shares doing well. 

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For the time being we have seen UK small and mid-cap shares delivering good returns, too.

Source: FE Analytics. Past performance is not a guide to future performance.

This, of course, is based on how the relevant indices have performed – and you will see very disparate results with individual shares in this space. 

But it’s striking how well a handful of funds have done in this period – and worth asking why.

Four winners

The FTSE Small Cap index may have returned almost 18% in a year but some funds are well ahead on that front.

The concentrated Odyssean Investment Trust Ord (LSE:OIT) has returned almost 50%, with Onward Opportunities Ltd (LSE:ONWD) on 28.5% and River UK Micro Cap Ord (LSE:RMMC) and Aberforth Smaller Companies Ord (LSE:ASL) each returning just shy of 28%.

What’s interesting is that, for now, a very focused approach has paid off. 

Let’s look at Odyssean as one example: the investment team back a very limited number of companies and use “constructive corporate engagement” to encourage improvements.

It’s not a fund for the faint-hearted when it comes to stock-specific risk. 

Top holdings Dialight (LSE:DIA) and XP Power Ltd (LSE:XPP) are on weightings of roughly 15% apiece, having enjoyed massive gains in the last year. 

The fund’s top 10 holdings account for more than 80% of assets.

To touch on the two biggest holdings, the Odyssean team noted in the trust’s last set of results (released in summer) that Dialight, a manufacturer of LED lighting for harsh industrial environments, had bolstered its margins via “improved pricing discipline, lower production costs and strategic purchasing”. 

It also resolved a long-running US court case and had more “self-help” to come, as per the investment team.

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Meanwhile, XP Power, which provides power supplies and power converters, has performed well in part thanks to demand from the semiconductor industry.

Onward Opportunities, meanwhile, has its own big bet via RentGuarantor Holdings (LSE:RGG), which accounted for almost a quarter of the portfolio at the end of September.

The company operates a UK professional rent-guarantee platform and saw adoption accelerate thanks to the implementation of Renters’ Rights Act. 

A recently published half-year financial report noted that the trust’s investment committee and board had agreed to take some profits here to reduce the weighting – meaning the fund had sold an initial fifth of its original investment, “more than fully recouping the company’s invested capital”.

The trust is very focused by other metrics, too, given that it has just 20 holdings.

Interestingly, the River UK Micro Cap trust does not have such a monstrous level of concentration, although its biggest position is still a decent 8.8%. 

If we then look at its sector exposures, the fund has good weightings to industrials, information technology, financials, healthcare and materials.

Aberforth Smaller Companies, which has something of a value approach, is also very well diversified. 

The fund has around half its portfolio in FTSE 250 constituents, with slightly less in the FTSE SmallCap.

Concentration: a blade that cuts

There’s something intrinsically appealing about concentrated funds. 

They have fewer holdings for you to consider, and might in that sense be easier to understand. 

They also offer big wins when individual holdings do well.

But this does, of course, cut both ways, and there are enough examples of concentrated funds that have struggled.

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Aurora UK Alpha Ord (LSE:ARR) shares have faltered this year, with the recent poor performance of Barratt Redrow (LSE:BTRW), a major holding, not helping.

And long-suffering backers of Nick Train’s funds will know how much it can hurt when a company on a double-digit weighting takes a hit.

Investors might therefore be wary of having too big a position in a concentrated fund, unless they understand that it can give them a rocky ride. 

But fortunately it does seem that some more diversified funds are also riding the small-cap recovery we have witnessed in recent times.