Royal London UK Smaller Companies: March 2024 fund update

• Henry Lowson has over 11 years of experience of investing in UK smaller companies

• He’s supported by a nimble team including co-manager Henry Burrell

• The fund focuses on quality growth companies trading at attractive valuations

• This fund features on the Wealth Shortlist of funds chosen by our analysts for their long-term performance potential

How it fits in a portfolio

Royal London UK Smaller Companies aims to grow an investment over the long-term by investing in some of the smallest companies in the UK stock market. Smaller companies typically have more room for growth than larger ones, though they’re more volatile and higher risk.

This fund could add diversification to the UK portion of a more adventurous portfolio, or one focused on larger, more established businesses. Its growth focus could also complement other investments in out-of-favour value companies.

Manager

Henry Lowson has spent his investing career focused on UK small and medium-sized companies. He joined AXA Framlington in 2005 where he was mentored under veteran UK investor, Nigel Thomas. He joined Royal London in September 2016 and became lead manager of the Royal London UK Smaller Companies fund.

Henry Burrell has served as deputy manager since January 2020 after joining Royal London in 2017 to focus on UK small and medium-sized companies. He has over a decade of experience in the investment industry, having started out on the Smith & Williamson graduate scheme. We believe he’s well aligned with Lowson’s investment approach with a focus on generating returns that are aligned with an appropriate level of risk.

Alongside this fund, the duo also manage a Mid Cap fund which targets slightly bigger companies using a similar process. Given the overlap in approach we believe the managers can comfortably handle these responsibilities. They also work closely with the broader UK equities team at Royal London, which provides opportunity for debate and challenge.

Process

The managers believe small and medium-size companies harness significant growth potential. The managers aim to use their experience to uncover hidden gems in this under researched part of the market.

Share prices can rise and fall based on short-term news or market sentiment, but over the long run they tend to be driven by the quality of the company. That’s why the managers conduct detailed company analysis to ensure the companies they invest in possess the traits that should enable them to grow more sustainably than most.

The managers take a long-term view and assess companies using the acronym ‘SIMBA’: scalability, innovation, management, barriers to entry and unique assets. They require companies to possess at least four of these characteristics to be considered for investment. They place significant emphasis on the capabilities and track record of company management, which is why they conduct over 400 company management meetings each year. This helps them gain a deeper understanding of their character, alignment with investors, and strategy for future success.

The managers look to invest in companies when their share prices look attractive when compared with their growth prospects. This leads them to favour quality companies that possess the financial resilience and leadership skills to thrive or survive when times get tough.

This analysis whittles their investment universe down to around 65-80 companies. New investments make up between 1-1.5% of the fund and this can go up to 3% as the managers’ conviction grows. This limit helps to keep the fund diversified.

The managers have made some changes to the fund over the last year. In recent months they initiated a new position in bathroom and kitchen product supplier Norcros with Lowson and Burrell positive on the steps taken so far by the new management team.

Culture

Royal London Asset Management was established in 1988 and is a subsidiary of Royal London, the UK's largest mutual life and pensions company. It’s well known for managing fixed income funds, but it’s also making headway in equity funds.

The UK team has a flat structure and appears to be a tight-knit community which encourages challenge and debate. Lowson and Burrell invest a significant amount of their own money into the funds they run. This helps to align their interests with those of investors.

ESG Integration

All Royal London fund managers have access to ESG ratings and analysis produced by the firm’s central Responsible Investment team. The firm asks that all managers incorporate this into their investment decision making processes, but our meetings with Royal London fund managers suggest the quality of ESG integration from fund to fund is mixed. The firm’s sustainability branded funds fully integrate ESG, with the support of the Responsible Investment team.

The Responsible Investment team coordinates company engagement and engagement case studies can be found in the firm’s annual Stewardship and Responsible Investment report. The firm also publishes a summary of voting activity on its website, and an interface allows visitors to search for all voting activity relating to a specific company, or any time period, and includes a rationale in cases where the team voted against a proposal or abstained.

Cost

The fund has an annual ongoing charge of 0.77%. Our platform charge of up to 0.45% per annum also applies, except in the HL Junior ISA, where no platform fee applies.

Performance

Henry Lowson has been manager of the fund since September 2016, but has a track record of running UK smaller companies funds going back to 2012.

During Lowson’s period at AXA Framlington, the UK smaller companies fund he managed between May 2012 and May 2016 delivered returns of 107.08%*, significantly ahead of the 82.30% return for the FTSE Small Cap ex IT index. Performance hasn’t been as good during his time with Royal London though. Since he became manager of this fund in 2016, the fund has delivered returns of 37.00%, behind the 45.43% return from the FTSE Small Cap ex IT index. We remain confident the managers continue to employ their well-established process and are well placed to pick out smaller companies with strong growth potential, although there are no guarantees.

Over the last year, the fund delivered a return of 0.16%, marginally behind the 0.52% return from the FTSE Small Cap ex ITs index, but faring better than the 4.17% loss suffered by the average fund in the IA UK Smaller Companies sector.

Our analysis suggests that industrial engineering company Hill & Smith and IT solutions business Bytes Technology Group were among the main contributors to the fund’s performance over this period. On the other hand, eyewear business Inspecs Group and audio technology group Focusrite were among the main detractors from the fund’s performance.