When it comes to investing in UK small and medium-sized companies there aren’t many teams who can match the success of Merian. We’ve followed them for a long time and their views are always worth hearing.
We spoke to them this week, and it wasn’t long before Brexit came up. There’s little doubt Britain’s efforts to leave the EU have been negative for UK shares, including small and medium-sized companies. But Daniel Nickols, head of the team and manager of the Merian UK Smaller Companies fund, was keen to point out that Brexit and the UK’s political crisis will be resolved at some stage, even if the precise timing is unknowable.
In the meantime, companies that do most of their business in the UK have been out of favour. Lots of investors simply aren’t interested. The Merian team thinks this has been overdone. They’ve been buying unloved UK companies they believe will deliver growth despite Brexit. At the same time they’ve reduced investments in companies that do most of their business outside the UK after many of them performed well.
Luke Kerr, manager of Merian UK Dynamic Equity, explained that these changes mean the team’s funds are more balanced now, between companies that make money in the UK and overseas. They could benefit if we see a positive resolution to Brexit, but they’re not totally beholden to the fortunes of the UK.
We also discussed with the team their investments in unquoted companies. These are businesses not yet listed on the stock market. These companies are higher-risk than their larger counterparts, and while they offer more potential for growth, not all of them will succeed.
In recent years more companies have decided to stay unquoted for longer. It’s been easier to attract money from investors, and it avoids the costs and time involved with a stock market listing.
The Merian team has therefore been able to invest in companies with similar characteristics to those they’ve always backed, except they’re staying unquoted for longer, and the exposure to unquoted companies has increased accordingly over time. They typically invest in well-established companies that have already achieved a degree of success, and are generating revenues. Secret Escapes, which offers discounted luxury breaks to members and operates in the UK, US and Europe, is an example. They’ve also invested in Starling Bank, the challenger bank, and Transferwise, the online provider of travel money.
In 2018 Merian launched an investment trust, called Chrysalis, to invest in promising companies that want to remain unquoted for longer than they would have historically.
Merian plans to grow Chrysalis by raising more money from investors later this month, some of which will be used to buy some unquoted investments from their other funds. They’ve reached the stage where they would rather hold unquoted companies in their investment trust than their open-ended funds. Too much as a proportion of an open-ended fund could be a risk because unquoted companies are harder to sell than those listed on the stock market. But too little and it’s not possible for the investments in these companies to make a meaningful difference to the performance of the fund.
As a result of the changes described above we expect the amount of unquoted companies in the Merian funds to reduce and in time be sold completely. In some cases the Merian funds might invest in Chrysalis to benefit from the performance potential of the unquoted companies, rather than invest in them directly, and we think this is a sensible approach.
The issue of funds investing in unquoted companies was recently brought into the spotlight by Woodford Investment Management. It’s important to note Merian has taken a different approach. Woodford owned a higher proportion of early-stage businesses. Merian is a minority investor focusing on more mature businesses that are generally more likely to list on the stock market in the short term. In addition, Merian holds a significantly higher proportion of their funds in companies that are regularly traded on the London Stock Exchange.
We continue to rate the Merian small and medium-sized company team highly. Their funds don’t currently feature on the Wealth 50 list of our favourite funds across major sectors. But if the fund(s) still meet your objectives we continue to believe they have the potential to deliver excellent long-term performance.