Downing Fund Managers boss Judith MacKenzie (pictured) is not a fan of volatile markets but is not scared of them either. In fact, the self-professed micro-cap value investor welcomes a break from the monotonous growth-driven bull market of the past decade.
Her £45m Downing Strategic Micro-Cap Investment Trust has done a decent job weathering the storm, with shares down just 6% year to date. The FTSE All-Share and FTSE Aim All-Share have fallen 11% and 22%, respectively, by comparison.
“What we find is our performance is so non-index correlated which, in these types of markets, gets people quite interested,” says MacKenzie.
“We are really engaged with the businesses we invest into. Therefore, we’re master of our own destiny far more in this type of situation than we are in momentum-driven markets where something with long dated cashflows is on a crazy valuation.”
MacKenzie knew early on she wanted to specialise in smaller companies. She cut her teeth at Allied Provincial Securities, helping companies float on the Unlisted Securities Market, the precursor to the Alternative Investment Market (Aim) exchange.
From there, she became a technology analyst during the dotcom bubble, which she jokingly refers to as the “TNT boom, boom years” where every stock she recommended went up. After the bubble burst in 2001, she launched her fund management career at Aberdeen Asset Management investing in Aim and private companies for its venture capital trust (VCT) range.
“That was a real privilege because I got to see companies that were literally coming out of universities and, at the same time, I got to work with companies that were coming onto the market,” MacKenzie recalls.
“What I realised was that sometimes the private companies are far more grown up and better structured in terms of their governance than the ones on the market.”
But she had ambitions to launch a micro-cap mandate of her own. “The one issue with microcap is that it is constrained in terms of the assets under management (AUM) that you can bring in just because of the size of the companies you’re investing in. Therefore, I had to find a small house to do it.”
She eventually settled on Downing, a company she had known for years but had always thought of as “a rather boring venture capital trust house”, albeit one run by “fundamentally good people”.
Founding partner and chair Nick Lewis and CEO Tony McGing agreed to let her set up her own fund management business in exchange for help rationalising several poorly performing Aim VCTs they had taken back in-house.
What started out as a humble business plan and a single micro-cap fund with less than £3m in assets, has blossomed into a £400m boutique, Downing Fund Managers, over a decade later.
Skin in the game
During the next several years, MacKenzie reckons the business can easily double in size and reach the £1bn AUM threshold.
She stresses that Downing FM is a “proper boutique” as it is home to mandates you wouldn’t necessarily find in larger fund groups. It has five Oeics in its stable, including the Downing European Unconstrained Income and Unique Opportunities funds, as well as a handful of listed vehicles, such as MacKenzie’s own Downing Strategic Micro-Cap Investment Trust.
“We’re finding that a lot of the larger houses over the years have been going bigger, bigger, bigger, when, really, smaller is better,” she says.
“You’re offering something that is not ‘me too’ and, more importantly, you are giving fund managers a platform to be able to express their own mandates and do something they believe in.”
It’s this entrepreneurial and “skin in the game” culture that has attracted heavy-hitters such as Rosemary Banyard and more recently Simon Evan-Cook to the business.
MacKenzie currently runs Downing’s IHT and VCT portfolios, as well as the micro-cap trust with co-manager Nick Hawthorn. Her UK Micro-Cap Growth Fund, which was the launch pad for Downing’s fund management arm, was wound-up recently.
MacKenzie’s approach involves taking strategic stakes, of between 3-25%, in the businesses she backs, which range from anywhere between £10m to £400m in size. After the high-profile liquidity issues around the Woodford Equity Income Fund, she realised her strategy was better suited to an investment trust structure.
She targets companies that have a market cap of under £150m to start with. But she doesn’t automatically sell out if valuations rise above this level, preferring to ride her winners and allow investors to enjoy in the upside.
Downing Strategic Micro-Cap has a highly concentrated portfolio of 14 stocks and can hold between 12 and 18 positions. However, MacKenzie says it is well-diversified. “We make sure we are not doubling up on sector exposures. We have everything from a recruiter, right the way through to widget manufacturers and companies in the digital media space.”
MacKenzie likes to keep cash levels (currently around 14%) quite high to top up her holdings if prices drop. But she also has a “good pipeline” of investment ideas.
Owning a slimmer number of investee companies makes engagement far easier, which is crucial when dealing with smaller businesses. MacKenzie is in contact with the management teams behind her investee companies on a bi-weekly basis at least.
“We do not wait until the interim results come out. In some cases, we have got monitoring rights, so we attend and sit in on board meetings and, in certain cases, we actually sit on the boards.”
Transformation story
One of MacKenzie’s biggest turnaround stories is cable and cord manufacturer Volex (10%). When she first sized up the business five and a half years ago, it looked like a lost cause. The company was on a $70m (£53m) loss-making contract manufacturing iPhone charging cables and had burned through 10 management teams in eight years, MacKenzie recalls.
However, the newest C-suite team had a clear concept on how to improve margins and grow by consolidation. Since she bought the business, shares have gone up tenfold, from 45p to 450p, although recently they have fallen below 300p.
MacKenzie is most excited about her portfolio holdings that are partway through their transformation journey, such as smoke alarm maker Fireangel. The Coventry-based company has “slipped on so many banana skins” in the past, MacKenzie says, but has a real opportunity to grow.
It has a solid marketshare, being one of only three big smoke alarm manufacturers in Europe, and after the Grenfell Tower tragedy, housing associations are under pressure to equip buildings with better safety devices.
“We have always said that the cycle for these types of investments is between three and seven years. We are about four and a half years in at the moment. That means we have got a bench of companies that have got a really good operational structure and have been through that pain of the restructuring.”
Geopolitical risk remains her overriding concern for 2022. While Covid and higher inflation have become more knowable and easier to price in, MacKenzie finds it “almost impossible to forecast” the impact political crises, such as the Russian invasion of Ukraine, will have on markets.
“I can only control our underlying investments and our knowledge of them. I have got no idea what is going to happen from a market perspective.”
This article first appeared in the March edition of Portfolio Adviser magazine
