Marlborough UK Micro-cap Growth: November 2023 fund update

• Guy Feld and Eustace Santa Barbara hunt for companies with growth potential in some of the smallest parts of the UK stock market
• 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 into a portfolio

IFSL Marlborough UK Micro-Cap Growth aims to deliver long-term growth by investing in some of the smallest companies in the UK, including those not listed on the London Stock Exchange. 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 - known as growth investing - 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.

Manager

Guy Feld has co-managed this fund since February 2012 and has decades' worth of experience analysing small and medium-sized companies. He is also co-manager of the Marlborough Global Innovation fund. In January 2021, Eustace Santa Barbara was appointed co-manager alongside Feld. He has over 17 years' experience in the industry and joined Marlborough in 2013 from Close Brothers.

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

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.

The managers run a diversified portfolio of around 180 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.

At the end of October 2023, the fund had around 2.15% 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 a standard annual ongoing charge of 0.80%, but we've secured a 0.09% saving for HL clients. That means a net ongoing charge of 0.71%. The fund discount is achieved through a loyalty bonus, which could be subject to tax if held outside of an ISA or SIPP. The HL platform fee of up to 0.45% per year also applies.

Performance

Since Feld began managing the fund in February 2012, it's performed well, delivering returns of 167.53%*, but hasn’t kept up with the 179.72% gain in the FTSE Small Cap ex Investment Trust index over the same period. It has performed better than the average IA UK Smaller Companies gain of 137.66% though. Past performance is not a guide to the future.

Over the past year the fund returned -11.68% to investors, underperforming the FTSE Small Cap excluding investment trusts benchmark return of 5.3% by some way. The fund has faced multiple headwinds over this period with the highest interest rates in 15 years having 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.

We expect the fund to perform better than peers in a rising market, but to fall further during downturns. There are no guarantees and all investments will fall as well as rise in value, so you could get back less than you invest.

Past performance is not a guide to the future. *Source: Lipper IM to 31/10/2023.

More on Marlborough UK Micro-Cap Growth, including charges

Marlborough UK Micro-Cap Growth Key Investor Information