This week’s Investment Q&A is with Elite Rated manager Rosemary Banyard of the VT Downing Unique Opportunities fund. Rosemary tells us why the UK market is becoming increasingly attractive and why stripping out short-term macro noise and focusing on the long-term is key to a sound night’s sleep.
(Recorded 15 August 2023)
[00:26] The fund had its three-year anniversary at the start of the year, so you’ve had a busy three years with Covid lockdowns, the Ukraine invasion, and high levels of inflation. How did you navigate these challenges?
[00:51] You’re quite right that it’s been a period with the most amazing number of unforeseen challenges, of which the two main ones are the Covid virus and the invasion of Ukraine. And a lot of the other [events have] been knock-on effects from that, whether it’s labour shortages, lockdown effects, logistics problems. And I probably would add to that, political upheaval in a lot of places.
One of the ways that I cope with it is that I’m quite clear that I don’t attempt to forecast macroeconomic factors, and I don’t base investment decisions on what we would call a top-down method. I don’t sit there and think, ‘Well, I think this macro event’s going to be the trend and therefore I’m going to find things to take advantage of that trend;’ I don’t do that at all. And that is incredibly liberating when you’ve got all of this going on. It’s not that I’m blind to it; obviously I read the same as everybody else, but it’s just that I’m looking for really excellent companies that have strong finances, sound business models, things that keep the competition out, that can keep growing. And that, in itself, lends you to invest in businesses which hopefully can survive all this. And it keeps the emotion out of it, and it helps you to sleep at night, actually.
[02:55] On the fund itself, small caps are always in the eye of the storm, but mid-caps have also had a lot of headwinds in the past 18 months or so. What’s the impact on performance and just how confident are you in these companies now?
[03:13] As you rightly say, I focus on UK small and mid-cap investing – and AIM – and that’s my heartland; it’s my core competence, it’s what I’ve been doing for decades, and so I’m not about to change that. It would be foolish indeed for any fund manager to go outside of their experience and go and do something completely different.
But it has been a massive headwind in the last certainly two years. And just to put some numbers around that; if you take it from the launch of this fund, which was March 2020 to the end of June this year, so three and a quarter years, it’s interesting that the FTSE 100 is up 49%, the FTSE 250 is up 37%, and the AIM 100, the top 100 companies on AIM, are only up 18%. So, when you think this fund has had roughly 30% on AIM and over 40% in mid-cap and at the end of June, I was up 43.5%, I’ve clearly outperformed AIM and have outperformed the mid cap index, the FTSE 250. But it’s still a struggle to keep up with the peer group, many of whom are investing in the very largest companies.
So, it is very important that people understand that, because a lot of people will look at where you rank against your peers and they’ll look at it and think, has she lost the plot? I don’t believe I have, it’s just that there’s been a big size effect. And it’s not just in the UK. It’s very famously happened also in the US where the top seven tech companies have massively outperformed and virtually nothing else has.
[06:51] A key part of your philosophy is long-term compounding. Tell us a bit more about that.
[07:10] Yes absolutely. So, you can have two businesses. They could be earning, having the same revenue sales; they could even actually be earning the same level of profit, but they might be doing it off very different levels of capital; one might be very capital intensive and it might be manufacturing or retailing or something, and it has to keep putting in lots of capital to keep generating those revenues and profits. The other business might be relatively low on the need for capital. I would say these businesses will tend to be long on intellectual property – they won’t necessarily have so much need for physical assets, for stock or factories etc. And I’m aiming to invest in the latter because you find that those businesses then generate loads more cash, because they don’t have to keep reinvesting in stocks or fixed assets or whatever it is, and they generate lots of cash.
This gives them options; you can buy back shares, pay lots of dividends, you can go and make bolt-on acquisitions, all sorts of things – you’ve just got lots of flexibility. And what you tend to find over the very long term is that those businesses – because they’re earning such good returns on the capital, the value of those businesses – that the profits compound up far faster than when you are having to redeploy a lot of that capital back into the business. And so, if you wait long enough, they perform really very well. Of course, it requires them to sustain a good, strong position to keep doing that.
But – and it’s very interesting with this fund – if I look at the companies that have performed the best in the fund, there’s a very clear group that have done the best, and they are the ones with the highest returns on equity, by and large. There is one exception, a company called Strix Ltd. which makes kettle controls, which actually has had a lot of debt and was very badly affected by the extended lockdown in China. But, generally speaking, these very high return businesses have just performed the best.
And an example that many people might know as consumers is Games Workshop Limited, obviously known for its shops that sell these fantasy toy soldiers. They have these fantasy worlds that they have created, Warhammer, Warhammer 40,000. And Games Workshop is a classic example of a company that’s makes very high returns on its capital. It’s well invested. And it’s very interesting [if you] consider the long term; so, it’s been on the market now about 30 years. It floated in 1994, valued at £35m pounds. The market now values it at £3.5bn. So, that’s a hundred bagger. And I should hasten to add that it’s hardly issued any shares. So, it really is close to a hundred bagger. And just the power of it is incredible. So, the revenues have gone up 7 times in 30 years; profits have gone up 34 times; and they just announced a dividend of 130 pence. They pay five dividends a year at the moment – they’re not all at that level – and so one dividend is now more than the price you would’ve had to pay for a share when they floated when you had to pay 115pence. So, that’s the power of compounding in real numbers.
[12:02] I would say a lot of the big returns in the share price have come in the last five or so years. It’s been investing and it’s been developing these fantasy worlds for years; it’s been investing in manufacturing and in shops and things, but it had a new CEO a few years ago who was internally promoted, and who seems to have galvanised the company into growing even faster. And, in particular, to have exploited their intellectual property. So, they now get quite a lot of royalties from licensing out their intellectual property on computer games, and they’re talking to Amazon TV about some TV shows as well.
Listen to the rest of Episode 275 of the Investing on the go podcast series, including Rosemary discussing the following:
- [05:41] Why the fund doesn’t invest in banks or oil and gas companies
- [13:36] How prevalent M&A activity has been
- [15:01] Two companies in the fund that have been the subject of bids
- [17:13] When it’s hard to ignore the macro “noise”
- [19:24] Views on the UK market’s undervaluation
Main image: c-d-x-PDX_a_82obo-unsplash
