Marlborough Special Situations: November 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 it’s been a challenging last two years, where the fund underperformed
• 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

The Marlborough Special Situations fund 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' focused 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.

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.

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 60% of the fund is invested in companies 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.

The managers run a diversified fund of 159 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.

In recent months, the managers have increased the fund’s investment in IT professional services company FDM Group but sold out of food retailer Greggs.

At the end of October 2023, the fund had around 2.78% 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 Environmental, 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.

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 Eustace Santa Barbara became co-manager of the fund in September 2014, the fund has performed well and delivered stronger returns than the IA UK All Companies peer group. Over this period, it’s risen in value by 52.02%*, compared with a 39.33% gain for the average fund in the IA UK All Companies sector. Though it must be noted that for most of this period, up until August 2021, the fund was in the IA UK Smaller Companies sector. 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.

Over the last year the fund has delivered returns of -9.38%, underperforming the IA UK All Companies return of 3.52%, by 12.90%. The fund has faced multiple headwinds over this period. This includes larger UK companies where many of this fund’s peers will invest more, having performed better than smaller companies. Rising interest rates through this period, which now stand at a 15 year high in the UK, have had a compressing effect on smaller company valuations.

The managers are optimistic about the outlook from here, believing that there is a significant valuation disconnect between how smaller companies in the UK are being valued compared to those in other regions. They cite the volume of merger and acquisition activity and continued interest in UK companies by private equity firms as a key signal of this.

We expect the fund to perform better than peers in a rising market, but to fall further during downturns.

Past performance isn't a guide to the future. Source: *Lipper IM to 31/10/2023.

More about Marlborough Special Situations including charges

Marlborough Special Situations Key Investor Information