Unicorn’s Outstanding British Companies portfolio challenges the notion that the country’s industry is going to the dogs. Its uncomplicated approach has produced top-decile returns.
Lion in Unicorn reveals its prowess
The past month has felt like an episode from Dad’s Army, with Private Fraser marching around saying, “We’re all doomed.” So it’s refreshing to speak to Chris Hutchinson from Unicorn Asset Management, who marches to a different tune.
According to Hutchinson, British management teams are world class. Our engineering skills are unequalled. We’re just having a spot of bother with the Germans and the Italians.
Hutchinson runs Unicorn’s Outstanding British Companies fund, a minnow in the IMA UK All Companies sector (it has just £8m under management) but a lion when it comes to performance.
The fund is in the top decile of performers over both one and three years and will no doubt be top decile over five when it passes its upcoming fifth birthday. It is has given its investors an 87% return over the past three years, compared with 49.5% for the typical UK All companies fund, and has even managed to keep its head above water this year. (Collinson continues below)
But it’s not a portfolio of micro-caps that is always going to be in the top decile - or the bottom. Rolls-Royce is its biggest holding, and you can’t get more British, or more outstanding, than Rolls-Royce.
Hutchinson co-founded Unicorn 10 years ago, and its history shares many of the features of British manufacturing: good-quality people, some great ideas, some error-prone execution, a near-death experience, but at last some signs of a comeback.
“We’ve been through a number of management changes,” says Hutchinson. “In July 2008 the co-manager left, performance was variable, and our marketing spend wasn’t achieving much. Our total funds under management at Unicorn troughed at £60m and it became a barely viable business.
”All our work goes into upfront analysis before we buy”
“But we decided to invest in new people, and over the past 18 months our profile has started rising. We think we can now grow in a managed and organic way. Over the last 12 months our equity income fund has gone from £2m to £36m, and now that Outstanding British Companies is coming up to its five-year record, we think that could go the same way.”
Unicorn has a total of £150m under management, with £60m of that in an Aim-listed venture capital trust (VCT). But there’s no reason why funds under management shouldn’t double, given their performance to date, he says.
“Outstanding British Companies is a scaleable fund, and although we have no ambitions to be the biggest in the market, we would like to see £250m-£300m in our funds over the next five years or so.”
Hutchinson’s approach to running money is relatively simple; the first rule is that you have to know and understand the business model you are investing in. “There are plenty of businesses, such as mining, and oil and gas, where we don’t really understand the business model. And we certainly don’t understand the business models of banks.”
There are no particular sector constraints, no themes, no bias to a size of company in the fund. But the average market capitalisation of a stock in Outstanding British Companies is £3.8 billion, so evidently it’s not in the mega-caps.
What stands out in Outstanding British Companies - like Hutchinson, I’ll call it OBC from now on - is that the portfolio has only 23 stocks. It has strong convictions in its stocks and a low turnover of investments.
“We run our winners. The basic rule to managing risk in the fund is that we will start looking closely at holdings above 5%, and take profits above 7.5%,” says Hutchinson. “Above all, we need to have confidence in both earnings and cashflow. Cashflow is hugely important, not least because it leads to dividends, and it is dividends that guarantee the discipline of the finance director.”
Every one of the stocks in OBC’s portfolio pays a dividend, with the average yield at 2.8%, although the fund has no specific yield mandate.
Turnover is spectacularly low. “Last year we didn’t buy a single new stock, although we sold two. All our work goes into upfront analysis before we buy.”
Now we get to what really makes OBC tick: “One of the best things a fund manager can do is to sit on his hands and ignore the noise.” That said, another of Hutchinson’s rules of fund management is to sell on the first profit warning. Whether through luck or skill, he hasn’t had many of late.
He insists his style works in most market cycles. In 2008, the market fell 32%, but OBC fell just 19%. In 2010 the All Share index was up 17%, but OBC managed a gain of 38%.
So what are these outstanding British companies? “I’m a passionate advocate for what we have in this country, how we can support it and how we can capitalise on it.
I do believe we have a huge amount of engineering excellence in the UK, massive product innovation, and I’m always gobsmacked by the quality of management teams that I meet. The British people are incredibly resilient; we are in the early stages of a readjustment from debt that we will come through.”
Industrial engineering stocks make up 12.5% of the fund, while aerospace and defence contribute another 11.9%. Electronic and electrical equipment add another 11.4%. Chemicals are 8.8%, and pharmaceuticals and biotech 8.7%.
At one end of the scale are Rolls-Royce and British Aerospace. At the other is Abcam, a maker and distributor of therapeutic antibodies linked to the human genome project. Hutchinson first invested through Unicorn’s VCT, putting in £1.5m. When it floated five years ago, he used OBC to buy some of the stock. It has gone up six-fold since then. “It’s now on 25 times earnings, so it’s not cheap, but it’s a star in its own specialised field, and there are any number of pharmaceutical companies in the US that might want to buy it.”
Not that Hutchinson wants Abcam to sell out. It would mean he’d have to find another stock for his portfolio. And more importantly, Abcam would no longer be outstanding, or British, and you get the feeling he’d like it to stay that way.
Patrick Collison is the Guardian’s personal finance editor.