Star performer: The Momentum Small/ Mid-Cap Fund.18 Oct 11
According to Morningstar data to September 30th 2011, the Momentum Small/Mid- Cap Fund has enjoyed a fantastic ten-year run. The fund had a one year performance of12.6%, a three year performance of 17% p.a. and a ten year performance of 25.6% p.a. The fund manager of the fund, Evan Walker has managed the R629 million fund since 2007. Liz Still, Research Editor of PSG Online spoke to him.
First of all, well done on your track record. Please could you start off by describing your investment universe? Which shares are you allowed to invest in and which ones are off the list?
New investments by the fund are restricted to small- and mid-cap shares only, with Top 40 excluded. However, if a share moves into the Top 40 the fund may continue to hold these shares if already held. The fund, for example, currently holds Woolworths and Steinhoff that recently moved into the Top 40 index. The fund must further invest at least 80% in small- and/or mid-cap shares, thereby limiting Top 40 exposure to 20%.
The idea, however, is that the fund is dominated by holdings in smaller market capitalisation and emerging companies that offer above-average growth potential, as well as established companies with sound recovery prospects from a low earnings base.
Large-cap stocks are often preferred by investors given these companies are generally dominant, well-established businesses (often referred to as blue-chip shares). The shortcoming is that you are investing in “past successes” where future growth may be limited relative to small- and mid-cap shares.
Could you explain your investment philosophy and how you go about choosing shares for this portfolio?
The philosophy of the fund is to invest in undervalued, well-capitalised companies that are mainly in a dividend-paying position. The success of the fund has been premised on investing and holding predominantly mid-cap shares that continue to reward investors with high dividends and strong cash generation. Selected small-cap shares have periodically complemented these returns.
Risk management is a key consideration in putting the fund together. Based on several factors, shares are classified according to their “riskiness” and then combined in a framework which helps limit risk in the fund.
Often funds holding positions in smaller companies are perceived to have more volatile returns, but the fund’s volatility has historically been in line with the average general equity fund, resulting in superior risk-adjusted returns.
Domestic-Equity-Smaller Companies funds tend to hold a large number of stocks. Yours is a slightly more concentrated; your top ten shares (including cash and money market holdings) constitute 54 % of the portfolio. The equivalent numbers from competitor funds in the small/ mid-cap sector range from an upper limit of 45.39% (Nedbank Investments Entrepreneur Fund) to 35.52% (Stanlib Small Cap Fund). Please comment.
As at the end of June, the portfolio you are looking at, we had a substantial holding in cash (15.4%) which may make the fund appear concentrated on your measurement. We have since deployed almost half of the cash into equity market weakness.
Now the top ten holdings (including cash) accounts for 43.2% of the fund, and the top ten shares - if you ignore the 8.6% cash holding - account for 37.1% of the fund. We are not really concerned with competitor funds and will allocate a substantial portion of the fund to shares where we have high conviction.
The shape of your portfolio is unusual. You have investments in 56 companies. Your fund has exposure of 2% or more to only 14 companies while in 42 companies your exposure is less than 2%. You could say that your portfolio has a very long tail. Please comment.
Over the last quarter we have consolidated some of our of our smaller holdings and now have exposure to about 50 shares of which 34 have allocation of less than 2% of the fund.
For some of the small-cap shares we have a market cap of less than R2 billion, so we are still substantial shareholders even if we only allocate a small portion of the fund to these shares. Restricting individual exposure to these more risky shares also helps us manage risk within the 20% of the fund that we generally allocate to “riskier” counters.
We see a lot of defensive stocks in your portfolio including branded companies, food retailers, healthcare companies. Will you switch out of these companies as we see signs of growth in the economy?
A substantial portion of the fund is invested in non-cyclical consumer shares. These companies will also benefit from growth in the economy. In fact, a number of them may benefit before their more cyclical counterparts. We only reduce specific shares based on valuation.
We are interested in your 3.94% exposure to Howden Africa Holdings. This share is only held by 15 other unit trust funds, and your exposure is the highest. Howden is a specialised air and gas handling company. Developments in the energy, mining and heavy industrial sectors are the main driver of group profits. A stable exchange rate and a strong commodity price cycle are necessary for medium term profitability. Please comment.
Howden is a direct beneficiary of the Eskom build programme supplying the cooling systems and maintenance backup to all Eskom power stations. Also, Howden has a large environmental cleaning business. Both these businesses are expected to grow over the next five years.
The most striking thing about your current portfolio (as of June 2011) is the high conviction of your biggest share, Pioneer Food Group Ltd, which is 8.98% of your portfolio. First of all, Pioneer is only held by 20 unit trust fund managers, secondly the next highest weighting is a mere 4.40% and thirdly and perhaps most interesting is that no other Momentum retail funds have investments in Pioneer. When there is a clear “high conviction share” it is more common for the company to be held across a range of funds within a management company. Please comment.
Pioneer is held in a number of Momentum pension funds. Liquidity constraints have prevented other retail funds buying the company. We have reduced the exposure to Pioneer to 8% of the fund, but continue to believe in its branded portfolio of defensive products.
We see that even though your fund is mandated to invest offshore, you do not have offshore exposure right now. Many fund managers are saying that there is great value to be found offshore at present. Please comment.
Global equities have been heavily sold down and valuations have become more attractive. At Momentum Asset Management we focus our company research on domestic shares and get our offshore exposure through our international partner, Momentum Global Investment Management. I, believe however, that the domestic market offers enough opportunities and the fund’s performance is a feather in the cap for truly South African companies.
It is always interesting to note the relative size of outperforming funds. Despite your fund’s success, it does not have the biggest market cap, relative to other funds in the Small/Mid-Cap sector. Please comment.
The small size of the fund does give it significant flexibility and the potential to generate returns through more tactical positions, which may not be available to larger funds.
Is your fund management style scalable? If not, would you cap the fund at a certain point?
We have a R1 billion targeted fund size at which we will consider capping the fund.
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