Gresham House duo on getting the inside track on IPOs

Due diligence involves paying contacts to spend time with target companies

An extensive network of private equity investors helps Ken Wotton and Brendan Gulston generate and scrutinise ideas for their UK micro-cap fund at a time when the wider case for investing in domestic companies is under pressure due the uncertainty around Brexit.

The duo’s private equity background stems from their time at private equity investment firm Livingbridge, whose UK funds business was acquired by Gresham House in November last year. As part of this move, the Microcap and Multi Cap Income funds moved into the Gresham House stable as did the Baronsmead Venture Capital Trusts. In total, 16 people moved over from Livingbridge.

Wotton (pictured left, above) joined Livingbridge in 2007 and is the primary fund manager of the micro and multi-cap vehicles that have consistently delivered top and second quartile performance in their respective sectors. Gulston (pictured right, above) works alongside Wotton as deputy manager on the funds and the two men are also part of a team running the Baronsmead Venture Trust and Baronsmead Second Venture Trust.

The duo also recently launched a small-cap fund with seed capital from Livingbridge and Gresham House, which has about 30% crossover with the micro-cap fund on holdings. The former focuses on companies with a market cap between £250m and £1.5bn, whereas the latter aims for the £50m to £250m bracket.

The small-cap fund is not being aggressively marketed now as the plan is to build a track record. “That will be something that we will look to market, but not yet,” states Wotton.

Ears to the ground

A solid grounding in private equity as part of Livingbridge has enabled the pair to build a credible universe of contacts who are in the right place to collect critical information on companies.

Gulston refers to a recent investment in Diaceutics, a data analytics business for pharma companies that launched its IPO (initial public offering) in March, as an example of where the duo were able to use their network to undertake a thorough investigation to get an independent and granular view on aspects of the investment case.

“We spoke to 10 or so people on that investment case, and we often do” says Gulston. “I doubt there would be many other investors who could do that to drive conviction. It’s the difference between us making a smaller investment versus saying, ‘we’re going to have a material cheque in this business’.”

As part of this due diligence, the pair sent one of their contacts to spend a day at Diaceutics’ head office to spend time with the management team, grill its CTO and speak with second-tier management. “We paid them the money to do it,” says Wotton. “To validate that this strategy makes sense in this market and to show we genuinely understand what they’re talking about.”

He adds: “While we can have a view on their credibility and believe what they say, someone who’s actually an operator in that market has a much more granular set of questions that can help us validate what we’re being told.”

Tried and trusted

These long-forged relationships mean the team often gets the opportunity to build conviction ahead of an IPO, get in early and secure a better allocation. “The fact management has engaged with us means they probably want us to have a bigger position in that IPO,” says Wotton.

Ken Wotton

But moving from a private to a public company – Gresham House is listed on the Aim stock exchange – has not changed what the team does when it comes to day to day portfolio management. It is still early days but Wotton says it’s very much “business as usual” under the new owner with the team and process both unchanged.

“Longer term it is a really good platform for us to support growing our business. The strategy of the plc is to act as a platform to help the underlying investment teams grow.”

There are no concrete plans as to how this growth will take shape, but Wotton says there is the intention to invest in marketing, IT and systems, as well as new products further down the line. More immediately the firm has hired a head of talent to access the best people for the business.

Small opportunities

In terms of the small-cap universe and Brexit, Wotton says given its reliance on the domestic economy, there are times when small cap will suffer when the UK is out of favour. But this can work in their favour: “If people are getting out it creates opportunities, because then there are forced sellers where we can take advantage.”

The IPO pipeline dried up in Q4 of last year as volatility returned to markets, but Wotton says the ensuing share price movements did throw up some opportunities in companies the team has been watching for some time. “Now there’s companies that are firmly back in the attractive camp, so that’s quite helpful,” he says.

The micro-cap fund targets a portfolio of 40-50 names – currently 45 – it uncovers through bottom-up stock selection resulting from its proprietary research. The fund is benchmark agnostic and aims for a high active share. Wotton estimates that 75% of the fund is exposed to domestic revenues, but believes the businesses the team invests in are in the control of the management rather than beholden to external risk factors.

It is about finding companies that can grow their earnings over the life of the investment regardless of Brexit. “We’re trying to find businesses that have some structural drivers or better advantages in their niche market that mean they can grow even if the economy’s not growing,” Wotton explains.

“Put that in the context of Brexit, it means we don’t have any companies in the portfolio that are involved in the automated supply chain or have acute issues that mean a sudden Brexit might hit them.”

The top name in the micro-cap portfolio is cooking oil filtration and fryer management services business Filta, which is 4.9% of the portfolio, followed by professional services firm Knights Group at 4.8% and wealth manager Mattioli Woods at 4.6%.

Beyond the noise

The micro-cap fund launched in May 2009 in the aftermath of the crisis and, while being in a bull market since, Wotton believes this longevity means it has weathered several macro-economic and geopolitical crises.

“We look through the noise and focus on the bottom-up analysis of companies we think can be resilient and grow, regardless of what is going on in the world,” says Gulston.

Brendan Gulston

According to FE Analytics, the LF Gresham House UK Micro Cap Fund has returned 1.1%, 48.8% and 72.2% over one, three and five years, respectively, versus the IA UK Smaller Companies sector’s -3.5%, 39% and 54.3%. It is first quartile over one year and second over three and five years.

The UK Multi Cap Income Fund launched in June 2017 and has remained top quartile over three months, six months and one year, returning 7.9%, 8.4% and 3% respectively versus the IA UK Equity Income sector’s 2.3%, 3.9% and -3.6%.

The team never invests in any company where it has not met with management face to face. Wotton estimates they meet 400- 500 companies each year and screens them on financial strength. The core sectors the team focuses on have been built up over 12 years and mirror those that Livingbridge private equity invests in.

In the micro-cap fund, business services is the largest sector at 33%, followed by financials at 23.1% and consumer at 19.5%. Technology media and telecom (TMT) is 17.8%, healthcare and education is 4.3% and cash is 2.3%. It avoids oil & gas, mining, real estate and biotech.

In terms of cap breakdown, the fund is predominantly micro-cap (sub £250m) at 73.5% of the portfolio, followed by small cap (£250m to £1bn) at 24.2% and cash at 2.3%.

Part of the process

The team is not a very active user of sell-side research, saying for the most part it is not very valuable. They have developed a process that is reliant on their own research and stock selection is based on the firm’s proprietary system that scores firms out of 10 based on six factors.

Speaking about not using a lot of external research, Wotton says: “That’s not because the analysts are bad, it’s just the way our process works. An analysis might be a starting point to go over the curve on something initially but we don’t often use their expertise to help us.”

As a result, the introduction of Mifid II last year has not affected the team’s research process, but Wotton does accept that anecdotally it has led to consolidation in the market. He adds this is not necessarily a bad thing given it has traditionally been oversubscribed in the small and mid-cap space.

“Hopefully, it results in fewer but better- quality providers in the area of the market we focus on.”

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