Can an inexperienced fund manager succeed? Are the economic risks from Brexit exaggerated? Anyone willing to wager ‘yes’ to both of these questions could consider an investment opportunity presented by the fall from grace by one of the country’s best-performing funds.
Last month Philip Rodrigs, the star manager of River and Mercantile UK Micro Cap (RMMC), which invests in some of the smallest but fastest-growing companies on the London Stock Exchange, was sacked by his employer for an unspecified breach of professional conduct.
This was a huge blow for shareholders in the investment company who had seen Mr Rodrigs more than double its net asset value since launch over three years ago as his stock picks in technology, industrial and consumer service companies repeatedly came good. Last year the shares soared 62% – making it the best-performing smaller companies fund in the UK – propelled in part by the stunning rise in Blue Prism (PRSM), a software robotics company whose own shares had grown more than ten times over since coming to market in early 2016.
Rodrigs was dismissed by River and Mercantile Asset Management after it tightened up its controls following an investigation by the Financial Conduct Authority into alleged price collusion by the firm and three rivals. The regulator said the firms had shared information about how much they were willing to pay for shares in two new companies floating on the stock market and another placing new shares.
Rodrigs disputes River and Mercantile’s findings and his departure was not linked to the watchdog’s statement of objections issued in November.
The impact of Mr Rodrigs’ shock departure on the fund was brutal. The Guernsey-based investment company lost a quarter of its value as its shares plunged from 235p at their peak in January to 173p a month later. Having stood at an unsustainable 17% premium above net asset value (NAV) the stock was left stranded at a discount of nearly 14% below NAV.
The savage de-rating reflected investor dismay at Rodrigs’ exit and River and Mercantile’s decision to hand the reins to George Ensor, an analyst with no experience of running a fund.
The change in manager couldn’t have come at a worse time. Although UK smaller company funds confounded their sceptics with a strong post-Brexit vote rally last year, the threat of a ‘hard’ divorce from the European Union has revived arguments that investors should stay clear. With their greater reliance on the UK economy, smaller companies are seen as more vulnerable to a downturn than the bigger and more global stocks in the FTSE 100.
Some experts also worry the fund’s focus on companies below £100 million risks getting stuck in illiquid – hard to trade – stocks should markets continue to be turbulent after last month’s falls.
There is one factor in its favour, however. The fund has an unusual policy of giving back shareholders some of their money when its assets grow beyond £110 million. This is a legacy of Rodrigs who insisted that if the fund got too big it would force him to buy stocks he didn’t like. Last June and December, it returned a total of £30 million after buying back shares at just under NAV when it hit £117 million and £114 million.
Winterflood Securities, the fund’s broker, says that with assets now at £101 million, Ensor only needs to generate 10% growth to trigger another return of capital, which because it would be priced at close to NAV would likely remove the discount.
‘It is feasible that the portfolio could generate sufficient growth within the next 12 months to warrant a third return of capital and we would expect this to act as a catalyst in narrowing the discount,’ said Simon Elliott, head of investment trust research at Winterflood.
UK Micro Cap’s discount has subsequently narrowed slightly to 11%, with the shares closing last week at 174.5p, making it look good value compared to its direct rivals – Miton UK Microcap (MINI) and Downing Strategic Micro-Cap (DSM) – which trade on much tighter discounts. However, it doesn’t look cheap compared to trusts investing in bigger smaller companies, such as Henderson Smaller Companies (HSL) and BlackRock Smaller Companies (BRSC), which trade on discounts of around 9-11%.
Investors are divided. ‘I’m not persuaded,’ said Jason Hollands, a managing director of Tilney Bestinvest, the wealth manager and funds supermarket, who was put off by Ensor’s lack of a track record and the illiquidity of micro stocks.
Darius McDermott, managing director of Chelsea Financial Services, was concerned about the possible impact of Brexit but saw the attraction of the discount. ‘There is a valuation opportunity,’ he said.
Shareholders are up in arms over what has happened. One big investor this month signalled its displeasure at the annual general meeting by voting against the company’s annual report and directors’ pay.
New investors would be right to be cautious too. However, while Ensor is a novice fund manager he is an expert in the portfolio having researched two thirds of the stocks, according to Winterflood. Moreover, Rodrigs did not leave the fund as vulnerable to Brexit as many assume. According to River and Mercantile, many of its companies are exporters with just a fifth of its money held in the shares of ‘cyclicals’ directly linked to the domestic economy, although its overall exposure to the UK is 45%.
If you think Rodrigs’ stock picks remain good, are willing to bet on Mr Ensor being a quick learner and that Brexit fears are either overblown or do not apply to this fund, then the unloved shares in River and Mercantile UK Micro might be a good punt.
A version of this article was published in The Telegraph on Saturday.