Nick Williams’s small-cap fund, Baring Europe Select, contains 100 stocks from a universe of only 1,200 – a preference for quality that has helped it to avoid some of the worst declines.
Back in March 2003, after three years of a bear market, the appetite for risk changed virtually overnight. The stocks that had lost out most made the strongest comeback. But by September the rally had lost momentum and the lower-quality stocks became relative laggards.
Fast forward to 2009. Again, the rally began in March. The stocks worst bombed-out by the credit crunch are the ones that have bounced back most. Are we about to see a repeat of history with a September market rotation?
At Barings, Nick Williams, who runs its Europe Select fund, would be quite happy to see a move back into quality. Europe Select is a small-cap fund, but at the top end of that sector, preferring good-quality companies with strong balance sheets and, above all, great liquidity. Indeed, Williams calls the fund a “small- to mid-cap fund”, selecting stocks from a universe of only 1,200 shares rather than the 5,000 small company stocks listed on European bourses.
Being in quality meant that the fund avoided some of the worst declines between 2007-2009, which is why it is topquartile (albeit in a small sector). More recently, as lower-quality stocks have raced ahead, it has tracked the indices rather than outperform.
But Williams is hardly about to change tack. The fund marks its 25th anniversary this month, celebrating a history like no other in its sector. It is close to £320m in size. Over the past year it is up 9% compared with the sector average gain of 1.3%, while over five years it is ahead 120% compared with the sector average of 82%.
Much of the gain over the past year is attributable to sterling weakness – in euro terms the fund is down 0.3% – but it is a highly creditable performance nonetheless.
Williams has been its manager since January 2005, so he can take most of the plaudits for its performance. He seems little affected by the fads of recent years, such as concentrated portfolios and thematic investing. Portfolio construction follows conservative principles aimed at avoiding much of the risk associated with investing in smaller companies. He has about 100 stocks in the fund, a number that has not changed much for several years.
“The Baring approach is growth at a reasonable price, and Garp is particularly well suited to smaller companies,” says Williams. “In small companies, share prices react far more to stock-specific issues than in larger companies. Research shows that around 70% of the performance of large- cap stocks can be attributed to top-down factors, but in small caps it’s only 11%. It means that if you want to invest in small caps it’s a bottom-up business with lots of market inefficiencies.”
Risk reduction is Williams’s starting point. Companies are rated for secure balance sheets, access to capital and stable track records. But he returns again and again to the theme of liquidity. He wants a portfolio that can be cleared out in 10 days, where every share can relatively easily find a buyer. The last place this fund will be is holding on to micro-cap stocks as the market plunges, with not a buyer in sight.
“We have a 10-day clearance rule for every single holding, but in fact it’s much below that,” says Williams.
No stock can be more than 2% of the total value of the fund, no matter what level of conviction Williams has. “I don’t believe in having any more conviction in one stock than in another,” he says.
Neither does he get particularly attached to his stocks. Turnover in the fund is relatively high, as he has a typical time-frame of 9-12 months. “We are looking for a low-volatility frame. If you keep stocks for too long you are saying ‘I will wear the losses and the volatility’. I’m not saying that is wrong, but it’s not what we do.”
Given that this is a Europe smaller companies fund and Williams is in London, does he spend much of his time roaming the continent?
He insists that he will always see a company before investing. But he adds: “It is surprising how many small- and mid-cap European companies will come over to London. We would have no problem filling up our days with meetings.”
Being in the bigger end of small caps is not the only thing that has helped performance since 2007. “We had already taken the view that the collapse in the US housing market would not just affect the US, and we believed valuations in European cyclicals and financials were looking stretched.
That mitigated some of the falls in 2007 and 2008. But we are not just fund managers for a downturn. We have tracked the indices since March.”
But he admits he is mystified by the recovery in some stocks. “It is very difficult to get enthusiastic about stocks where there has been a profit warning.”
Small caps in Europe are currently trading on valuations significantly higher than large-caps, but there is still value, Williams says. Most earnings forecasts are based on conditions earlier this year rather than the more favourable outlook of recent months.
He could talk stocks all day long. All his top 10 holdings are between 1.6% and 2% of the total portfolio. At the top is Swedish Match, which makes chewing tobacco and low-price cigars. It is highly cash generative and largely overlooked by the market, Williams says.
Next is Scor, a French reinsurance company enjoying widening margins after the decline of the Bermuda reinsurers. More of a special situation is Belgium’s Bakaert, maker of tyre rods for trucks. Its auto industry exposure means it had a terrible start to the year, but the market has not yet woken up to its strong position in China, the only country where truck sales are booming.
Generally, Williams is keener on the entrepôt economies of Belgium and Holland, which are leveraged plays on a recovery in world trade. But he remains cautious on banks.
Caution and conservatism are not the usual attributes of small-cap fund managers, but maybe that is why this fund has performed so well and outlived all its peers.