Merian UK Smaller Companies: January 2021 fund update

Joseph Hill | Fri 29 January 2021

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• Daniel Nickols is an experienced smaller companies investor with over 20 years’ experience
• Nickols has the support of a well-resourced and knowledgeable UK equities team
• The manager considers both bottom-up and top-down factors when it comes to choosing stocks – a key difference from many smaller companies funds
• The fund does not currently feature on our Wealth Shortlist of funds chosen by our analysts for their long-term performance potential

How it fits into a portfolio

Smaller companies have the potential to grow faster than larger, more mature companies and whilst small in nature, their reach can be far and wide. However they can be higher risk. This fund aims to deliver capital growth to investors and has the flexibility to rotate between investment styles and shift between value and growth as the manager sees appropriate. We believe the fund could complement investments in larger UK or global companies as part of an adventurous portfolio.

Manager

Daniel Nickols, Head of UK Small & Mid Cap at Merian, has been the lead manager on this fund since January 2004. He is a University of Cambridge graduate and began managing money in 1997 at Albert E Sharp. With a track record spanning over 17 years on this fund, Nickols has demonstrated his ability to select great companies, but he hasn’t done this alone.

The fund adopts a team-based approach so Nickols has the support of a well-resourced team of five fund managers and four analysts all focused on analysing small and medium- sized UK companies. Longevity is something that sets Merian apart from their peers. Nickols, Richard Watts and Luke Kerr have all been on the team since 2001/2002, initially working under Ashton Bradbury - an industry veteran whom they regarded as one of the best investors in this sector.

Jupiter’s Matt Cable has recently joined the team following Jupiter’s acquisition of Merian in July 2020. Cable was previously a member of the smaller companies’ team at M&G and adds to the team resource in this area.

Process

Nickols begins with ‘top down’ analysis of the economy. He and the team assess current macroeconomic conditions and the outlook for economic growth, paying close attention to emerging trends across different industries. They then form a view on which sectors are most likely to benefit based on these factors.

This is then complemented with bottom-up analysis which helps the team identify what they believe to be the best companies within these chosen sectors. The team place significant emphasis on meeting companies, where they form a view on the quality of management within the firm. Businesses must display at least one of three key characteristics to be considered for inclusion in the portfolio. These are: sustained above average earnings growth, ability to deliver unanticipated profit upgrades and the potential to re-rate relative to the market. These criteria whittle the investable universe down from over 650 companies to a portfolio of around 80 holdings.

The team are style agnostic so can invest in both growth and value stocks. This flexibility gives the manager the opportunity to take advantage of style rotations and deliver consistent performance across the market cycle, although this is not guaranteed. Ultra-low interest rates lead them to favour growth stocks at the moment and Nickols believes this is likely to remain the case for some time yet.

Smaller companies have been volatile over the past 12 months. At the start of 2020 the team bought positions in several cyclical companies – these are companies that are particularly sensitive to where we are in the economic cycle. The pandemic resulted in significant falls in the share price of many of these companies, one example being airliner Jet2. The team looked beyond the short-term noise and bought more shares at cheaper prices. The hit markets took from coronavirus also presented opportunities to add companies such as JD Weatherspoon and Bodycote to the fund. These positions were later sold though after their share prices recovered later in the year.

In contrast, Nickols sold a position in Johnson Service Group, a specialist in work wear and linen services. Despite a favourable view on the management team, the impact of Covid-19 changed his investment case with demand for hotel and restaurant linen falling dramatically. Nickols believes this revenue stream will return but he sees limited upside to the current share price.

Around 1.2% of the fund is invested in unquoted companies, which aren't listed on a stock market, which adds risk. We expect the amount of unquoted companies in the fund to reduce and in time be sold completely.

Culture

In July 2020, Jupiter Fund Management completed the acquisition of Merian Global Investors which now forms part of the Jupiter Group.

We think the culture within the team is attractive. Fund managers are given autonomy to invest in the way they see fit and believe will benefit investors over the long run, but with an appropriate level of challenge from others in the business. The business setup allows Nickols to focus his time and attention on fund management. Nickols is incentivised based on the performance of the fund which we think aligns his interests with those of investors.

Fund managers receive support from the Sustainable Investing and Governance Research teams. Nickols also forms his own views on ESG (Environmental, Social and Governance) issues and incorporates them into his process, believing them to be important to the long-term quality of a business.

Cost

The fund has a standard annual ongoing charge of 1.03%, but we’ve secured a 0.175% saving for HL clients. That means a net ongoing charge of 0.855%. The HL platform fee of up to 0.45% per year also applies.

Performance

Over the long term the fund has delivered strong returns to investors. Since Nickols became lead manager in 2004, the fund has outperformed the IA UK Smaller Companies sector average by 454.5%*. Our analysis suggests this is down to the manager’s stock picking ability. Remember all funds will rise and fall in value, so you could get back less than you invest.

The fund invests in medium-sized companies as well as smaller companies. This means it can look quite different to its smaller companies’ benchmark, creating a different return profile. The fund’s outperformance has been relatively consistent since its inception, with only two notable periods of Nickols falling behind the benchmark: at the beginning of 2009 and at the end of 2018.

Over the past year the fund returned 7.6%* whilst the IA UK Smaller Companies sector average increased by 7.3%*, although past performance is no guide to future returns.

Boohoo Group and ASOS have been two of the fund’s top performers over the past 12 months. The dramatic shift from retail to online shopping has provided a tailwind which has helped online businesses to acquire new customers. Another notable performer was Liontrust Asset Management, which has seen its assets under management rise partly as a result of increasing investor interest in its ESG offerings, an industry wide development.

The fund does not currently feature on our Wealth Shortlist of funds chosen by our analysts for their long-term performance potential. While we think this fund could deliver good long-term returns for investors, we currently have high conviction in other managers within the UK Smaller Companies sector, which already feature on the Wealth Shortlist.

Past performance is not a guide to the future. Source: *Lipper IM to 31/12/2020.

Find out more about the Merian UK Smaller Companies fund including charges

Merian UK Smaller Companies Key Investor Information