Thanks to a change of direction in its distribution strategy, classic boutique Unicorn is seeing traction in its flagship Income fund and it is driving inflows into the group’s fund range
Investors could be accused of a lack of imagination when it comes to the UK Equity Income sector. While the largest funds in the sector continue to see considerable inflows, the top performing fund over three and five years – the Unicorn UK Income fund – until September of last year remained at under £50m in size. But that is changing with Unicorn’s new distribution strategy, which is driving asset flows into the group’s fund range.
As with a number of the boutique groups, generating strong performance has not historically been a problem for Unicorn. Four out of the group’s five funds are top quartile over three years. The UK Smaller Companies fund is currently the only exception and following the recent appointment of Simon Moon as co-manager last year, performance has started to improve there too and it is now top quartile over one year.
But gathering assets has proved tougher, as investors have been increasingly reluctant to invest outside the bigger brand names. Until relatively recently, the group’s flagship UK Income fund was still small, with three of the group’s funds sub-£10m. The Mastertrust, for example, is just £6.4m despite strong and consistent performance.
The group determined on a change of strategy in October of last year, appointing independent distributor LGBR Capital to replace their in-house distribution function. LGBR has experience in distributing products for specialist groups – including ‘alpha’ exchange traded fund provider First Trust and alternatives boutique Isis Asset Management. It also has an established sales team, each with different areas of expertise – private client wealth managers, IFAs and so on – that Unicorn’s management felt they could not replicate.
Fund manager John McClure says that the early signs from the partnership have been promising: “Previously we did all the sales and distribution in-house, but LGBR has 15 salespeople and we cannot afford that. We have worked with them for a long time and they have taken us to distribution opportunities that we would never have been able to consider before. It has been a big change, but they have made a real difference for us.”
This has been seen in fund flows. The UK Income fund is now about £180m in size and was listed among the top 20 best selling funds on the Barclays Stockbrokers platform for May. The group also now has all its funds on the Cofunds platform in a bid to increase their accessibility – Cofunds said that it had had requests from its advisory and execution-only clients. The fund was also recently put on the Sanlam Private Investments’ White List, at the same time as the group axed Neil Woodford’s £11.9bn Invesco Perpetual High Income fund. This has helped build momentum.
To date, the majority of the flows have been into the Income fund, but McClure says the group is seeing increasing interest in the Mastertrust, run by Peter Walls as a fund of investment trusts.
The new distribution partnership has also given the group some scope to consider launching new products. Although McClure cannot give details yet, he says the group has ambitions to extend its current fund range and has definite plans in place.
Any new initiatives will be powered from the group’s existing investment ‘engine’. The fund management team is seven-strong and operates across the five retail funds and one venture capital trust. The process is classic stockpicking in style – using company specific, proprietary research, with no recourse to brokers. The group believes in getting to know management teams and understanding companies intimately. The research focuses on finding those companies that may have been mispriced by the market, either owing to their size, or to a misreading of their growth prospects.
The group is predominantly focused on small and mid cap stocks, but with a quality bias. McClure sees himself as conservative, preferring companies that are prudently managed, with strong balance sheets. The group believe in concentrated portfolios – a stock must be sold to make room for new ideas, but all the funds have relatively low turnover.
The process is then sliced and diced to suit the different fund mandates. On the income fund, for example, McClure seeks out a growing dividend. He believes strongly that companies can deliver a reliable dividend stream while at the same time growing their business.
McClure says that in this part of the market risk management is key to strong long term performance. He prioritises companies with little debt, that have dividend cover of at least two times. He is unlikely to keep a company that cuts its dividend and he avoids the ‘dividend traps’ – those paying a high absolute dividend that are likely to cut. Similar risk management strategies apply across the group’s remaining funds as well.
For example, with an eye to the downside risk, McClure has avoided areas such as the high street retailers and housebuilders. He says: “The UK high street will be wiped out by the internet in due course. There is now an app that allows a shopper to punch in a bar code from a shop and it will tell them where to get that product cheaper. It is difficult to see what is going to be left – the next generation will have grown up shopping on the internet.”
Elsewhere, the Outstanding British Companies fund aims to draw out the best companies operating within the UK; the Free Spirit Fund – co-managed by McClure and Fraser Mackersie (who joined the group in 2011) has a broader mandate, and strives to incorporate higher weightings in technology and innovative companies. The UK Smaller Companies is, as its name suggests, a traditional 30-50 stock smaller companies fund, now run by Moon, who joined the group last year.
This approach has proved protective in more difficult times. For example, McClure says they have been happy with the performance of the funds during the recent sell-off, adding they have largely protected investors’ capital.
The UK Income fund has undoubtedly had its best years relative to the wider sector in rising markets, but fell in line with the market in 2008 and 2011.
Of course, having had such as strong run of performance, investors may legitimately question whether it can be sustained, particularly if – as is the care for the UK Income fund – there is very strong growth in assets. McClure says he has not had to change his process to accommodate the inflows so far, increasing the UK Income portfolio by just two stocks since last year. Near-rivals Chelverton, who run a similar strategy, has said it may have to re-think its strategy at £300m and it is likely that a similar level would apply for Unicorn. McClure is already accustomed to taking time build and exiting positions.
For McClure, he says that income-generative smaller companies are likely to deliver structural outperformance over time. It is telling that the smaller company income approach has spawned a number of imitators. For example, Marlborough has recently launched a similar fund, Gervais Williams at Miton has also taken a similar approach with his new investment trust, but for McClure, the real endorsement was Standard Life moving into the sector, taking the lid off their Standard Life Equity Income Unconstrained fund.
He says: “It is nice to have a big house say ‘we understand what you have been up to for the past 13-plus years’. It is a good benchmark for us – there is a mini-subsector starting to develop.”
McClure points to research from Numis, which examined the performance of the Hoare Govett Smaller Companies index, finding that high yield smaller company stocks produced almost double the performance of non-yielding smaller company stocks. He adds: “This was the first piece of empirical evidence that proved what we were talking about, that really good companies can pay dividends and still support their growth.”
The other meaningful area for the group is its VCT. At £64m, it is one of the largest and most well-supported trusts in the sector. It had a difficult quarter at the end of 2012, dropping 6 per cent after four of its Aim-listed companies saw profit warnings – Green Compliance, Hasgrove, Mears Group and Mattioli Woods. However, its long-term record is strong. It is top of the VCT Aim quoted sector over one and three years. Managed by Chris Hutchinson, the trust is up 147.2 per cent over the past five years, compared with a drop of 0.8 per cent for the average trust in the sector.
Part of the reason for the outperformance of the VCT has been a significant closing of the discount. Yet, the trust remains on a discount of about 15 per cent to net asset value and, as such, there may be scope for further narrowing if performance continues to be strong. The trust has also sold out of holdings in the group’s Outstanding British Companies fund and the UK Income fund.
Unicorn is a classic boutique – it does just a few things, but it does them well. It is now seeing traction in its flagship Income fund thanks to its change in distribution strategy after a number of years of strong performance but few assets. It will hope that this success can start to filter down to the remainder of its funds and provide it with a platform from which to build its range.
The independent views
Gavin Haynes, investment director, Whitechurch Securities
“We certainly rate Unicorn as one of the specialists in what they do. They are focused on UK smaller companies and they are one of the groups we look at for this area. Their closest rivals are groups such as Miton and Aberforth, both of which have funds with a similar approach. While we would certainly consider the equity income fund, a number of the group’s funds are too small for the buy lists of the larger advisers. We prefer not to own more than 5 per cent of a fund.
“That said, liquidity is much more of an issue in this part of the market. Equity income is a very popular sector and the equity income fund has seen some strong inflows. It obviously cannot get near the size of the monolith equity income funds in the sector and would probably have to take action before it reached £500m or change its philosophy.”
Darius McDermott, managing director, Chelsea Financial Services
“Unicorn specialise in small company investing, Aim and VCTs. They run a number of products with the standout performer being their income fund. Run by John McClure, this fund has an excellent track record. He looks for strong balance sheet, niche products, strong earnings and cash flow strong management. The fund invests entirely in small caps. The group also run a number of other UK funds but again the focus is on small caps. They also have a good fund of investment trusts, which has been a top quartile performer.”
Jason Hollands, managing director, Business Development & Communications, BestInvest
“In our view Unicorn are a top-notch, independently owned specialist in the UK small cap space. We rate their VCT highly, which is the largest and most mature Aim-focused VCT in the market. While at most fund companies a £62m vehicle would be considered small beer, for a small boutique like Unicorn this is a materially important mandate which gives us an additional degree of comfort that this will get the right level of tender loving care. The current tax free yield is 4.6 per cent, which is attractive against a backdrop of low interest rates and sub-inflation bond yields.
“The VCT is lead managed by Chris Hutchinson who has a strong record as lead manager of the Unicorn Outstanding British Companies fund since its inception in December 2006. The non-qualifying element of the VCT is invested across three of Unicorn’s open-ended funds; Unicorn UK Smaller Companies, Unicorn Free Spirit and Unicorn Mastertrust, all of which have outperformed over five years.
“More broadly it is Unicorn Income, managed by McClure, that is increasingly on the radar given its top performing rankings and ahead of inflation yield. Despite the innocuous name, this is, in effect a niche smaller companies income fund. It has a stellar record and, despite the small cap focus, a lower level of volatility than a bog standard UK equities funds. With many traditional, large cap equity income sectors such as tobacco and utilities having appreciated significantly in recent months, small cap income space is becoming more appealing for yield hunters.
Unicorn Asset Management was founded in 2000. It is privately-owned, with about 60 per cent held by fund managers and staff. It now runs about £280m across five retail funds and one VCT. It focuses predominantly on small and mid cap companies, using its own proprietary research.