Marlborough Special Situations: January 2023 fund update

• Eustace Santa Barbara and Guy Feld hunt for small and medium-sized UK companies
• They follow the same investment philosophy and process established by their highly regarded predecessor, Giles Hargreave
• Long term performance has been strong, but the fund underperformed over the last year
• This fund does not feature on our Wealth Shortlist of funds chosen by our analysts for their long-term performance potential

How it fits in a portfolio

IFSL Marlborough Special Situations aims to deliver long-term growth by mainly investing in UK smaller companies. Companies of this size are often overlooked by other investors which can provide an opportunity for the managers to uncover hidden gems.

This fund could complement other investments focused on larger global or UK companies. Additionally, given its focus on companies capable of above average earnings growth it may work well alongside a 'value' fund, investing in out-of-favour companies with the potential to recover. Smaller companies are higher-risk, and we believe they should only form part of a well-diversified adventurous portfolio.

In August 2021, the fund's investment policy was changed so only 60% of the fund would need to be invested in 'smaller companies' – defined by Marlborough as those smaller than £2.5bn in size. Previously the fund needed to have at least 80% invested in the bottom 10% of the UK stock market by size. As a result, the fund changed sector from IA UK Smaller Companies to IA UK All Companies.

Manager

Eustace Santa Barbara has co-managed this fund since September 2014. He joined Marlborough from Close Brothers in 2013 and has over 17 years' experience in the industry.

Guy Feld was appointed co-manager in January 2021 and has decades' worth of experience analysing small and medium-sized companies. He is also co-manager of the Marlborough Global Innovation fund, which predominantly invests in small and medium-sized technology companies from both the UK and US.

Collectively, the duo also manage Marlborough Nano-Cap Growth and Marlborough UK Micro-Cap Growth, which focus on even smaller UK companies. Both managers have built up an impressive track record and we believe they leave few stones unturned when it comes to finding small companies with big potential.

They benefit from the support of an experienced team, several of whom also manage other UK-focused funds. New additions include James Workman who joined the team in July 2021 from Rathbones where he covered small and medium-sized companies.

Veteran smaller companies investor Giles Hargreave also continues to serve as a sounding board for the managers but is no longer involved in day-to-day management.

Process

Feld and Santa Barbara like companies that are easy to understand and have the potential to grow significantly over the long term. If successful, they will invest more in their favourite investments, or 'run their winners’. Before any investment is made, they like to meet with company management and assess their quality.

The team also delves into a company's financial strength. Healthy balance sheets are preferred, and they don't like excessive levels of debt. They also consider companies that have a great product or service but appear to be 'under-valued' due to short-term issues. Maybe they've missed a profit target, or the management team made some unpopular decisions. Either way they must have the potential to turn things around.

With over 2,000 companies to pick from, the managers are spoilt for choice. Around half of the fund's holdings are listed on the AIM index, a junior market of the London Stock Exchange. They also have a considerable number of investments in the FTSE 250 index of medium-sized companies, many of which they've invested in since their infancy. Sector-wise, they find most opportunity within industrials and consumer discretionary businesses.

The managers run a diversified fund of around 150 companies. Historically the managers have invested in over 250 but over recent years they have gradually reduced this number. This means they can invest more in their favourite companies as their conviction grows.

The managers recently increased their investment in technology company Playtech, and bought shares in telecommunication and utilities company Telecom Plus. Veterinary services provider CVS Group however was reduced.

At the end of December, the fund had around 1.82% of its assets invested in unquoted companies. The managers have committed to not making further investments into the shares of unquoted companies, though the weight of existing unquoted investments in the fund can change as the fund size changes. Investors should be aware that investment in unquoted companies is higher risk and they can be considerably less liquid (their shares are harder to trade) than those traded on established stock exchanges.

Culture

Fund managers are employed by Hargreave Hale, an asset manager which was bought by Canaccord Genuity, a Canada-based financial services company, in 2017. Canaccord provides them with plenty of resources while allowing the managers the freedom to run their funds the way they see fit. The way Canaccord rewards them ensures they're focused on the long term, which is a good thing for investors.

Marlborough Fund Managers, from where the fund gets its name, is a separate company. It provides the fund's marketing and distribution and doesn't get involved in the investment side of things. It's an uncommon set up, but one that's been in place for many years, and seems to work well and suit everyone involved.

ESG Integration

Marlborough's focus on smaller companies means integrating Environment, Social and Governance (ESG) is more challenging, given a lack of external research coverage and quality ESG data. However, the firm is increasingly considering ESG factors, with a focus on governance, and has bolstered the quality of the ESG data available to them by incorporating insights from fund managers and analysts. We will continue to monitor how the firm's approach to ESG evolves over time.

Some Marlborough fund managers have told us they've begun tracking companies to see how they improve on ESG, and whether they're doing what they said they would. The managers have suggested they'd be prepared to sell a company if ESG concerns couldn't be resolved. Even so, we believe Marlborough's ESG integration is at a very early stage, and engagement activity is not as systematic as some peers.

Cost

The fund has an annual ongoing charge of 0.79%. The HL platform fee of up to 0.45% per year also applies.

Performance

Since September 2014 when Santa Barbara became co-manager, the fund's delivered strong growth. The fund was in the IA UK Smaller Companies sector for most of this time. Our analysis suggests this is down to the managers' ability to invest in companies with strong futures ahead of them. Past performance is not a guide to the future. All investments will fall as well as rise in value, so you could get back less than you invest.

The fund's historically held up better than both the benchmark and the IA UK All Companies sector average. Although, it's important to remember that smaller companies are less liquid, which can heighten falls if many investors try to sell at the same time.

Over the past year the fund returned -31.57% to investors, underperforming the IA UK All Companies sector average return of -9.25%*. Among the most significant detractors from performance over this period were eyewear company Inspecs group and content and intellectual property services company RWS. Some of the fund's holdings did perform well over the year though, among these better performers were its investments in semiconductor business IQE, and software provider, Cerillion.

Past performance isn't a guide to the future. *Source: Lipper IM to 31/12/2022.

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