FOCUS ON A FUND MANAGER: SCHRODERS
At Scottish Widows, we take a rigorous approach to selecting and monitoring the funds that we offer for investment. In this issue of FundsTalk, we take a closer look at the SW Schroder US Smaller Companies Fund, managed by Robert (Bob) Kaynor. The £900 million fund, of which Scottish Widows holds around £90 million in aggregate, is invested in 110 small-cap US companies spanning a range of sectors.
Bob has 25 years’ specialist experience in small and mid-cap US companies. As the New York-based Head of US Small & Mid Cap Equities for Schroders, he leads six analysts specialising in small and mid-caps, supported by a research function. As Fund Manager of the SW Schroder US Smaller Companies, he is responsible for investment strategy.
THE SCHRODER US SMALLER COMPANIES FUND IS A £900 MILLION FUND OF WHICH SCOTTISH WIDOWS HOLDS AROUND £90 MILLION
WHAT IS SMALL-CAP?
By UK standards – a US small cap is actually pretty big. Some US small caps have a market capitalisation big enough to rank in the FTSE 100 index. Kaynor says the fund invests in companies with a market capitalisation of between $200 million and $4 billion.
The strategy is to focus on downside protection through careful portfolio construction, giving investors access to what is deemed to be a riskier asset class (relative to large-cap equities) at a lower level of risk. The fund has a long-term investment horizon, holding stocks for an average of three to four years, sometimes longer.
A key strength, says Kaynor, is that his team have an average of 20 years’ investment experience and average tenure of seven to eight years. In jobhopping Wall Street, tenure often tends to be far shorter and he is proud to have retained his team, providing continuity and consistency for the fund.
UNDERSTAND, SCRUTINISE, ANALYSE
The team conducts rigorous ‘bottom-up’ company analysis for stock selection. The approach is to:
- understand the business model
- scrutinise the financials
- analyse valuations
- calculate a three-year target share price, based on the company and industry history, dynamics, and other key factors.
When assessing a potential investment, the first question is: “What do we lose when we are wrong?” and the second question is “How could it play out when we are right?” It eventually comes down to ‘buy, bin or defer’ and if buying, how much.
“We’re numbers geeks…because numbers don’t lie and every story must be backed up by the numbers. If that’s not the case, you’d look at an opportunity with a very incredulous eye,” says Kaynor.
The team also monitor what a company publicly says it will do and what it actually does, particularly concerning capital allocation. “If there’s a mismatch, it’s a flashing signal and we’re out.”
As the focus is ‘bottom-up’ analysis, the emphasis is on individual companies, not sectors. However, there are some sectors that the fund tends to avoid and others in which it holds several stocks that could benefit from common industry dynamics.
It holds shares in two offsite house manufacturers (Cavco and Skyline), a sector experiencing an upsurge in demand. It also holds shares in two companies (Pacira and Flexion) involved in non-opioid pain management – both have growth opportunities linked to an opioid misuse crisis in the United States.
Avoiding certain sectors (such as biotechnology, because of issues over accurately gauging risk) sometimes acts as a tailwind, at other times a headwind, Kaynor says. Maintaining a consistent long-term view and careful stock-picking is more important.
The fund’s holdings fall into three categories:
1. Mispriced growth – the fund invests in these for capital growth
2. Steady Eddies – for capital preservation
3. Turnarounds – for idiosyncratic growth
The portfolio currently comprises: 58% Mispriced Growth stocks, 38% Steady Eddies and 3% Turnarounds. The relatively low weighting in turnarounds reflects the fact that we are at a relatively late stage in economic recovery.
These are companies experiencing growth but whose share price does not reflect sales growth, incremental margin growth or rising cash flow return on investment. Often the wider market has missed the significance of key developments – perhaps not surprising, given that sell-side analysts on average spend only 12% of their time analysing a company’s long-term prospects, according to Kaynor.
The fund invested in auction house Sotheby’s as a ‘mispriced growth’ stock. It had begun to transform under new Chief Executive Tad Smith, with very little debt and significant free cash flow. Smith introduced new business opportunities and mitigated downside risks for sellers by establishing pools of buyers and contingent bids.
(Several weeks after the FundsTalk interview, Sotheby’s was acquired for $3.7 billion by billionaire Patrick Drahi who will take the company private. The recommended offer of $57.00 per share represented a premium of 61% to Sotheby’s closing price before the offer was announced.)
These are companies with stable or recurring growth characteristics, strong free cash flow and a good balance sheet, providing ballast in difficult markets. Pest control firm Rollins is a classic Steady Eddie. The fund held the stock for 11 years and it moved from small to mid cap. Rollins cut an innovative deal to install tubes into homes being built offsite to allow easy access for pest control, resulting in a big uptake in orders and customer retention, which compounded returns. Kaynor says the market largely missed the significance of the deal at the time.
These are companies whose growth engine has ‘broken’, but which have catalysts for change in place and evidence that growth is returning. Recovery prospects are not dependent on a financial event such as a refinancing; they are linked to factors such as a new management team, the sale of an asset or perhaps a ‘take-out’ situation.
As a veteran investor, Kaynor exhibits a healthy scepticism: “You can only believe half of what you see and none of what you hear,” which is why he remains an unapologetic ‘numbers geek.’
Our carefully selected externally managed funds provide building blocks to create bespoke investment portfolios. The SW Schroder US Smaller Companies fund, along with many others covering a wide range of asset classes, geographical locations, sectors and management styles, is available both for individual or workplace pensions. Ask your Scottish Widows contact for more details.
Robert ‘Bob’ Kaynor has had a distinguished 25-year investment career during which he has amassed deep expertise in small and mid-cap US equities. He joined Schroders in 2013, initially as Senior Equity Analyst, becoming Research Director in 2014 and then Co-Portfolio Manager before assuming his current role this year. Bob began his career as an analyst at RCM Capital Management in 1994, progressing through roles spanning analysis, portfolio management and research, as well as senior management positions at several investment firms. Immediately prior to joining Schroders, Bob was Chief Investment Officer and Managing Member at Ballast Capital Group. He is a Chartered Financial Analyst (CFA) and has a BSc in Economics with Financial Applications.