For this month’s fund review, Juliet Schooling Latter, research director at FundCalibre, looks at a fund which, in her words, ‘has taken its fair share of punches’ but soon could well see it stand out from the crowd.
I’m going to let you in on a little secret – all of the funds we rate at FundCalibre are not first quartile over every timeframe. When we review them at our various investment committees throughout the year, the questions we often ask for those facing challenges are whether a manager is practicing what they preach and whether we can see the road to alpha/income in the future.
The reality is that good funds can be out of favour for various reasons – such as market-cap, style or sector biases. WS Montanaro UK Income is a good example of a fund which has had all of these headwinds in the past five years. Managed by Guido Dacie-Lombardo, the fund offers something very different from the standard UK equity income fund, given it focuses on small and medium-sized businesses with a quality growth bias. Holdings within the 50-stock portfolio will also offer an attractive dividend yield or the potential for dividend growth.
I can almost hear the sighs from readers at the calls for a catalyst for recovery in UK mid and small-caps once again – but the story is much more nuanced than that. Having performed well prior to 2020, this fund has faced numerous challenges, including interest rates, which have particularly hurt growth stocks and small-caps.
There are plenty of other factors at play. UK quality has underperformed the broader market by almost 40% since 2020, while growth has underperformed value by almost 75% over the same timeframe. Small-caps have also underperformed large-caps by 69%, with outflows of almost £4bn from the sector since 2022*.
Strangely enough, an episode of The Simpsons comes to mind. It was an old one which saw Homer become a professional boxer. His strategy was simply to let everyone hit him until they ran out of steam and he would push them over. This worked until he met the heavyweight champion Drederick Tatum, who is based on Mike Tyson.
I want to be clear – I’m not comparing the fund to someone with a thick skull and a flabby body, but it has taken its fair share of punches. The case for this fund is the benefits of the focus on quality companies, which has been reflected by the rise in earnings over the past five years (EPS saw a 7% rise in the past 12 months alone)*. This has come despite the PE of the fund falling; on a shiller P/E basis UK small-cap stood at 14.6x earlier this year, the lowest seen since the Global Financial Crisis*.
“I can’t control P/E as it is driven by cost of capital, which spiked up and has since fallen off badly. The last six months have seen it go to an all-time low, so I can’t see it being a headwind from here. What I am focusing on is earnings continuing to rise at almost double digits. We’ve seen the Covid fall and recovery as well as rates rise in 2022, but we’ve got through it all,” Guido says.
“More recently we had the UK Budget and Trump’s tariff/policy situation – which has dampened expectations. But earnings are still high single digit year-on-year and expectations are getting on for double digit growth in the next 12 months.”
He believes the fund’s focus on companies above £1.5bn means it has not been subject to a huge amount of M&A activity, with many of the companies acquired often having a value tilt, which the fund tends to avoid. He also says there are plenty of attractive companies sitting on the sidelines at potential new investment ideas.
“You can paint a scary picture of the market now, but I am not scared. A third of my companies are net cash and the overall gearing across the portfolio is really low, while free cashflow cover of the dividend is over 2x,” he says.
The portfolio typically has a rough split between mid and small-caps, while the dividend yield has typically stood at 3.5-4%. Looking at the top 20 names we can see yields vary markedly between 1.5%-7.5%, so the fund can also access those growthier names.
Examples include discoverIE, which sells electronic components to a variety of end markets. Guido says it has a long track record of mid-single digit organic growth, supplemented with M&A but also excellent operating leverage and margin expansion over time. Despite this, he says the company is trading at a figure that implies it will grow at 3-4% per annum forever, without any further M&A or margin expansion.
Another is Bloomsbury Publishing, which has actually been one of the biggest detractors year-to-date. The firm has both the mainstream line (the likes of Harry Potter and author Sarah J. Mass) as well as an academic arm. Guido says the latter has been hit by Trump policies around academia in the US, causing business to be a bit sluggish. While this may not turn around instantly, he says Bloomsbury remains well positioned and is looking at licensing all its academic text to large language models, which will give it greater margins.
“Although there is some disappointment that Sarah J. Mass has yet to finish her latest book, which is a big growth driver for Bloomsbury publishing, it will eventually come through. HBO is also making the new Harry Potter series coming out in 2026 – which will bring a new generation of people into the books,
“The business is a great example of looking through short-term cyclicality to a solid, long-term business, with strong indicators for the next 18 months,” he says.
The fund’s clear process and focus on research has worked consistently well over a very long period previously. Yes, there have been challenges in the past five years, but there is renewed hope that many of these headwinds are dissipating and the focus on quality growth in the income space will soon see this fund stand out from the crowd once again.
*Source: fund presentation, 31 March 2025
Past performance is not a reliable guide to future returns. You may not get back the amount originally invested, and tax rules can change over time. Juliet’s views are her own and do not constitute financial advice.
Main image: absolutvision-82TpEld0_e4-unsplash-
