Strategy & Team
The fund aims to provide investors with a growing dividend, paid quarterly, alongside capital growth. This is achieved through investing in focussed portfolio of UK small & mid-cap companies with the FTSE 100 excluded from our investment universe. Our process seeks to exploit the wider universe of UK small & mid-caps by blending the potential for both compelling shareholder distributions and earnings growth that can compound over the medium to long term. The process is a quality value approach and is implemented by dividing our investment universe into three potential return buckets. Each defined by a level of payout ratio and corresponding return on equity to help us identify those companies striking the right balance of reinvesting excess returns back into the business and shareholder distributions that best suit their given business model and market position.
The fund is managed solely by Josh McCathie, but investment ideas and coverage are drawn from across the wider UK equities team at Downing. With two other mandates which are also focussed on UK small and mid-caps that team has near 100 years of experience running UK small and mid-cap mandates.
Current portfolio positioning
The fund is larger positioned into two different camps currently. Firstly, those businesses that we believe are leaders in a given niche or that their longer-term structural growth opportunity is undervalued by the market. We believe these are the businesses that will to be able to offer the fund earnings and dividend growth that can compound over the medium to long term regardless of wider macro considerations. The second are those we would perceive as overlooked quality. This maybe those where we believe quality aspects are tarnished by poor management, badly performing divisions or belonging to out of favour sectors, but where we have confidence in the delivery of a catalyst to remove these issues to allow the market to revalue the quality aspects of the business.
Key investment opportunities
A theme the portfolio has been playing through most of 2023 and expects to continue to play out in 2024 is the heightened claims inflation in both primary and secondary insurance markets. This was caused by years of soft market conditions followed by three years of high catastrophes and then heightened inflation resulting in insurers having to funnel capital into covering previous claims rather than writing new business. Insurers that avoided aggressively writing business in the soft market were rewarded with the opportunity to write very attractive new business when capital was withdrawn from markets. The fund is playing this theme via positions such as Conduit Holdings and Sabre Insurance.
Another theme we are playing is taking advantage of the discounts available in companies with perceived exposure to the UK consumer but where we believe the competitive advantage of the business is overshadowed by consumer strength concerns. Here we are looking for businesses with evidence of good returns on capital and a track record of growing market share through the cycle that can help protect earnings when the weak competitors fall away. Examples of companies contributing to this theme are Hollywood Bowl and The Property Franchise Group.
Josh McCathie is a Fund Manager at Downing Fund Managers
