Cazenove launched the Absolute UK Dynamic Fund in September 2009, managed by Neil Pegrum who had an exceptional track record running a fund which used a similar strategy, but which was not available to private investors. Following strong demand at launch, the fund was closed to new investment in order to restrict its size and keep the fund small and nimble. Since launch, the fund’s performance has been disappointing and in April it was announced that Neil Pegrum would leave Cazenove to join Soros Fund Management.
The fund has now been taken over by Paul Marriage, who has worked alongside Neil Pegrum for the last five years. We believe he is an excellent fund manager, and he is also familiar with the portfolio. We therefore feel that he should be able to improve returns over the long-term.
Neil Pegrum initially constructed the portfolio by investing in a broad range of companies, using his expertise to identify smaller, more dynamic companies with the potential to grow significantly. A good example is Filtrona, a mid-sized manufacturer of specialist filter and plastic products. It has high profit margins and is conservatively managed. However, during last year’s market recovery, the shares were left behind as more speculative companies found favour with investors. Since then, the company has seen positive earnings news and investors are now finally appreciating its growth potential. It remains a large holding in the fund.
While part of the fund’s objective is to invest in shares that will grow in value, it also uses shorting to try to profit from shares that fall in value (please see below for an explanation). However, this relies solely on the manager making the right calls and can be risky in volatile markets. Neil Pegrum felt several medium-sized companies were overpriced following 2009’s strong recovery, and was therefore ‘short’ of these shares. In fact they continued their strong run into 2010, and this proved a drag on performance in the early part of this year.
Following Neil Pegrum’s departure, the fund has seen some significant redemptions, mainly from other financial institutions. Because the market for small and medium-sized companies is higher risk as it tends to be less liquid (i.e. there are fewer buyers and sellers, which can make it hard to buy or sell large numbers of shares at a fair price), this was a difficult period for Paul Marriage as he had to liquidate positions quickly in order to return money to investors. The fact that he has managed to accomplish this without materially affecting the fund’s performance is to his credit, particularly in the volatile markets of the past few months.
We believe Paul Marriage has coped well since he took over and the fund has outperformed the FTSE All Share Index during his time at the helm, albeit over a short timeframe and remember past performance is not a guide to future returns. He feels that the recent volatility has also created some interesting opportunities, for example many smaller companies are currently being taken over by larger rivals, driving up their share prices.
Paul Marriage has also been sceptical about the sustainability of government spending since the general election and has been ‘short’ of companies reliant on this spending. This is finally beginning to see rewards, since the Budget when spending cuts were announced. He has also been ‘short’ of some property companies and has therefore been able to take advantage of the sector’s recent weakness.
As the fund has the ability to use wider investment tools, it has the potential to deliver positive returns in a variety of market conditions. However, there are no guarantees. The fund’s focus on smaller companies can also lead to greater volatility, so investors need to adopt a long-term view. The fund is still closed to new investment, and is therefore ineligible for the Wealth 150 list, but we firmly believe Paul Marriage is an excellent manager and in our view existing investors should generally continue to hold the fund. Of course, if our views change we will keep investors fully informed.
Key Features of the Cazenove Absolute UK Dynamic Fund
Shorting - an explanation
Traditionally investors buy assets they believe will rise in value. Shorting is different. The principle is that the fund manager borrows shares he believes will fall in value and then sells them, hoping that by the time he needs to repay the lender the share price will have fallen. The difference between the two prices is the profit or loss. For example:
1. Manager borrows 10,000 shares and sells them for £2 each = £20,000.
2. Purchases these shares six months later at 80p each, cost = £8,000.
3. Profit = £12,000
Had the share price risen by the same amount, it would have cost more to purchase the shares than received from selling them, resulting in a £12,000 loss. Shorting can be effected in a number of ways; fund managers generally short via contracts with a broker rather than actually taking delivery of the shares. This example also ignores transaction and other costs, but it hopefully explains the principle.
