Unicorn focused on improvement

Unicorn Asset Management might have top-performing funds in its stable but the smaller company specialist is not about to become complacent. Sarah Godfrey reports.

Unicorn Asset Management was founded in 2000 by Peter Webb, then manager of the Eaglet investment trust, the Premier UK Smaller Companies fund and the Acorn Smaller Companies Income fund. At the end of 2001 it launched its Oeic, which now contains four subfunds, the newest of which, Unicorn Income, was launched in May 2004. Other funds include two Aim VCTs. Based in London, the company now manages 375m of assets and markets its funds through the Matrix group.

One might not expect to spend a meeting with the manager of the top-performing UK All Companies fund over three years, in a boardroom almost wallpapered with fund management awards, discussing how things can be improved. But cumulative performance is a fickle thing, as Unicorn Asset Management can attest. Over three years, its two Oeic funds with a three-year record (reached, incidentally, only this month) are both top in their respective sectors. Over one year, two out of the three funds are bottom or nearly bottom. Its Eaglet and Falcon investment

Unicorn is a smaller company specialist, constructing focused portfolios and investing for the long term. It concentrates on finding undervalued companies that are well managed, financially sound and positioned for growth. Chief executive Peter Webb, who also manages most of the funds, says: “Our style is to try to improve our selection process every year – to make an assessment of the past and to try to improve our chances of success in the future. That is as true for the most senior members of staff as for the most junior. You can keep getting better and there are plenty of examples to learn from, including new issues, deals and your own successes and failures. You have to ask yourself questions.”

Webb continues: “We have a very experienced team. Unicorn has enabled me to bring in senior people who understood me and what I was doing and who also had credible positions and respect within the industry. In building that wheel of knowledge we hope that our collective ability exceeds that of the individual team members.”

He has found the process of building the business since it launched in March 2000 – with an expansion in assets from 140m to 375m and in staff from three to 10 – more challenging than his role as a fund manager, though it is the latter that has won him the awards.

In the past year Unicorn has split its analyst and fund manager functions and expanded its investment team, which now includes four fund managers and four analysts. Analyst Jeremy Utton says: “Our objective is to gauge whether businesses are superior operating companies and whether we can own them for less than the market thinks they are worth. We pass those judgments to the fund management guys, who rank that material in a way that best suits the allocation of capital. The managers allocate the capital – they decide whether something is a buy, a hold or a sell and they control the timing of those decisions. The analysts simply give them the right bullets to fire.” He adds that the core of the approach is “trying to buy 1 worth of value for 60p”.

Webb adds: “We have a very good engine room. It brings consistency to our investment decisions. Fund managers seldom have the skills to be fund managers and to be great analysts too. They are two distinct skills. The business was built by fund managers but we have established an analyst unit and we are getting a better model for success than in the past. There is always room for improvement, and we want the strongest team.”

Despite the short-term performance downturn, Unicorn’s contrarian style and longer-term successes have found it friends among fund strategists. Hargreaves Lansdown investment manager Ben Yearsley says the UK Smaller Companies and Free Spirit funds are on his firm’s Wealth 150 recommended list, and Hargreaves’ funds of funds own a substantial stake in the new Income fund, launched last summer. Unlike many income funds, Webb says he and investment director John McClure will seek out companies with good growth characteristics as well as a high yield.

UK Smaller Companies and Free Spirit also get four-star ratings from BestInvest, as does the Eaglet investment trust. “The other trusts have various gearing problems or invest in splits,” says investment trust analyst Simon Moore.
Moore is unimpressed by the Unicorn Mastertrust fund of investment trusts, despite its first place in the Active Managed sector over three years and its second place over one year. “Peter Walls is OK but his fund is small,” he says. “He had a good record as an analyst at Credit Lyonnais but his Unicorn fund has never done that well. It looks better now that Derek Larcombe is no longer in that sector.”

Moore and Yearsley both see Webb as the key to the Unicorn phenomenon. “Peter Webb is a safe pair of hands, although he has his own particular ideas,” says Moore. “It’s a big risk if he’s not there. He’s a maverick with contrarian ideas. He is also a pretty volatile chap.”

“Unicorn had a shocking year in 2004,” adds Yearsley. “The smaller companies fund was down about 3% when the best fund in the sector was up about 30%. Peter Webb is a good fund manager, but you have to ask yourself how long you should stick with an underperforming fund. If it doesn’t turn around soon you might consider selling it – but then you know that as soon as you do sell it, it probably will turn around. The funds have periods of poor performance and then go ballistic. You either try to time that or you just sit through it.”

As Moore points out, however, bouts of underperformance are inevitable when a fund manager takes a contrarian stance. “Because Webb is contrarian it can take the market a while to catch up, but in the long term it is good.”
Webb picks up on this point: “In September 1999 at the start of the TMT boom I was running the top-performing smaller companies fund [Premier UK Smaller Companies]. At the height of the boom we were the bottom performer and at the end of the boom we were top again.

“We’ve been in this situation before and kept cool. It doesn’t get any less painful but if we strongly believe in our strategy and we understand it, who is going to have the last laugh? Never mind buying 1 of value for 60p. If we buy 1 of value for 40p, we’re up 50% before the market begins to realise it wants what we’ve got. At present there is extreme undervaluation in the unpopular sectors and extreme overvaluation in the most popular ones.”

Despite its poor relative showing over the past year, Free Spirit is Unicorn’s best performer in absolute terms over three years, sitting atop the UK All Companies sector with a gain of 88% versus the sector average rise of 4.6%. Webb has a simple aim for Free Spirit: to be the top-performing All Companies fund over 10 years.

He points out that many people fail to grasp the significance of the name UK All Companies, and expect the funds in the sector to be biased to large and mid-caps. “Free Spirit is about growth companies. The UK All Companies sector enables you to do anything, which is good when what you are looking for is the greatest growth companies. It happens that most of those companies are small, but they have real attractions.” He adds that as those companies achieve their growth potential, the average market capitalisation of the fund will rise.

He says that the timing of the launch, at the end of 2001, was crucial. “It was a once-in-a-lifetime opportunity to buy companies for much less than they were worth. Last year the growth premium disappeared, and nowhere more so than in small-cap growth. Free Spirit took a bit of a back seat but it is off to the races now. These companies are going to go ballistic.”

Webb is adamant that Free Spirit will be the top All Companies fund over 10 years, and says this will be “a huge billboard” for the business. Moore feels the aim is realistic. “It’s good to choose funds run by ambitious people. I think it’s a laudable aim, and he could get there,” he says.

The worst performer in absolute terms is Eaglet, whose three-year decline of 17.6% is in marked contrast to the average gain for UK Smaller Companies investment trusts of 36.4%. Webb points out that the UK Smaller Companies Oeic is run very similarly. “We’re not talking about companies that can reach the FTSE 100 here,” he says. “These are companies that are unlikely to be 1bn but they are very out-of-favour companies in deeply cyclical sectors, which are capable of delivering substantial returns.”

With regard to the underperformance, he says: “We have suffered most in relation to decisions made several years ago. They were big decisions and they didn’t work out, but we haven’t been finding more of those disasters.” But he adds: “The single most important message is that we have grown quite fast in a testing time for investors, but today we own what we own, and that includes a number of decisions we wish we hadn’t made. It is painful. But when we close out our disappointing investments, we will be in a strong position.”

Webb is disappointed that the UK Smaller Companies and Eaglet funds were awarded the “wooden spoon” in some quarters for their performance in 2004. “Today Eaglet’s NAV is at 3.60 and it peaked at only 4.39 – so it’s still up 260% since launch. That’s hardly a wooden spoon,” he says.

The team says the big bets in deeply cyclical sectors such as industrial services will pay off in 2005 as the market realises that debt and consumer-related stocks have become an unsustainably large part of the economy where, as Utton puts it, “there is nowhere for the earnings to go”.

Webb says: “Prior to becoming overcapitalised the participants start to leverage more speculatively – and then it goes pop. That is how the wheel turns. What is fascinating is markets’ apparent belief that those days will never end.”

He adds: “The stockmarket is slow and is on the back foot in terms of seeing the shift in emphasis. We know the change from non-productive to productive assets has happened, but the market still values those opportunities cheaply. At some point there will be a major divergence and the difference between the top and bottom fund managers will be huge.”

If Yearsley and Moore have a criticism regarding Unicorn, it is that they do not always feel they are being kept fully up to speed with the reasons for the underperformance. Yearsley says: “In periods of poor performance you would expect some kind of regular comment, but they are not very good about communicating what goes on. We have some of the best access to Unicorn, so you wouldn’t blame some other advisers that don’t have such good access for being worried.”

Webb’s confidence in the validity of his investment strategy is solid, however, and to him a year of underperformance is hardly worth getting worried about. “A lot of what goes around comes around. It may be that cycles are extended these days, so stockmarket contrarians have to wait forever to be proved right, and self-doubt kicks in.

But he adds: “Unicorn is a great learning opportunity and even I have barely started in terms of my ability to add value in the business. When I look at my colleagues I see people at different stages of the ladder, all with the potential to climb higher than they realise. Collectively, we can go a long way.”

Unicorn may be a small company, but it has big ambitions, and somehow one feels it would not be wise to bet against it.