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David Kimberley
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Updated 20 Sep 2023
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Disclosure – Non-Independent Marketing Communication

This is a non-independent marketing communication commissioned by Rockwood Strategic. The report has not been prepared in accordance with legal requirements designed to promote the independence of investment research and is not subject to any prohibition on the dealing ahead of the dissemination of investment research.

At the end of July, the average holding for investment trusts in Morningstar’s UK small cap sector had a market capitalisation of £811.35m.

Compared to the multi-billion pound firms that we see at the top end of the London Stock Exchange (LSE), that does look ‘small’. But it is substantially larger than the £75.1m average market cap for companies in the FTSE AIM All-Share Index.

It’s a crude comparison to make but it reflects the fact that investors looking to get dedicated exposure to the smallest companies listed on the LSE are unable to do so through the majority of trusts that invest in UK small caps.

That is not always a deliberate omission on the part of managers. Liquidity constraints in these smaller companies, as well as the size of many UK small cap funds, preclude them from investing at the smallest end of the market. In other words, there are structural problems that prevent them from investing, rather than the companies themselves being the causal factor.

Rockwood Strategic (RKW) is one of the only trusts that invests solely in this segment of the market. The trust typically invests in companies with market caps below £150m. It also runs a highly concentrated portfolio that is usually comprised of around 20 companies.

The strategy was developed by manager Richard Staveley, who took over the trust in September 2019. Returns since then have been strong.

From Richard taking up his position through to 12/09/2023, share price total returns equalled 86.6%. By comparison, the average equivalent return in the small cap trust sector was 19.6% and, for the FTSE Small Cap Index, it was 24.2%.

Performance is reflective of the differentiated approach that Richard takes to markets. Rather than being a simple ‘buy and hold’ strategy, the RKW team invest in a manner that is more comparable to a private equity fund.

Prospective investments are categorised as ‘core’ or ‘springboard’ holdings. For core holdings, RKW aims to take a position that is between 5% to 15% of NAV and at least 5% of the company itself. Springboard investments tend to be between 2% to 4% of NAV but are allowed to build up if performance improves.

Richard favours a more value-driven style and the RKW team look for firms that have good free cash flows and a proven business model. Investments are also made in firms that may have experienced a period of poor performance but have clear potential catalysts to turn things around. Regardless of what a given company’s situation is, the ultimate aim is to identify those that can double in value over a three to five year period.

The private equity-style component comes into play when the RKW team take an active part in the strategic direction of the company. They will often take a seat on the board and push for changes that will improve the business and ultimately enhance returns for shareholders.

One example of this process playing out was Crestchic. The load-bank manufacturer and hire company had a poorly performing division exposed to oil and gas markets and had lost focus on return on capital.

In 2020, the RKW team successfully put forward a new non-executive director (NED) for the board. Following this there was management change and in 2022 Nick Mills, another RKW team member, joined the board, also as a NED. The problem division was sold shortly afterwards, funds were reinvested in the core business, profits expanded and early this year the company was taken over by Aggreko. This resulted in a 4.8x money-multiple for Rockwood.

Flowtech Fluidpower is another example. Currently one of the trust’s largest holdings, the business has been under-delivering operationally for some time. RKW Advisory Group member Jamie Brooke joined the board in 2022 as a NED and through engagement with the chair Roger McDowell and other stakeholders, management change ensued. The new CEO was formerly COO of FTSE 100 member RS Group. The firm is now on track to increase profitability with a transformation programme underway.

As the Crestchic example suggests, companies in the RKW portfolio tend to be picked off by private equity firms or corporate trade buyers. Richard believes about 80% of holdings will ultimately be acquired in one of these types of transactions, with the remainder kept public and shares sold to another on-market buyer.

A key factor here is how concentrated the portfolio is. Top holdings in the RKW can be in excess of 10% of NAV. This means that acquisitions at large premiums, which often compound on top of prior share price returns, have a sizeable impact on the portfolio, compared to large, diversified portfolios, where holdings are often only about 1% of NAV.

Given the strategy’s success to date, you would think it would attract more like-minded market participants, thus depleting the number of opportunities that exist.

That looks unlikely to happen. As noted, larger funds simply can’t touch many of the companies that RKW invests in. That creates a virtuous circle for RKW as it means there is close to zero analyst coverage of these companies, meaning there is more of an informational edge for the trust’s managers to take advantage of, through their significant due diligence process.

That is not a guarantee of success moving forward but with the trust’s more value-oriented strategy arguably benefiting from a return to higher interest rates and the inability of large players to enter the market, RKW remains in a strong position to deliver on its goals and provide investors with unique access to the smallest corner of the UK stock market.

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