None of the information provided is investment or tax advice. You should always read the associated risks before deciding whether to invest. These can be found on the product pages as well as in our risks overview. Please confirm you have read the information above.
1. UK small-cap equities lost momentum in Q4 following the Budget, which increased taxes on businesses.
2. Fund performance: The fund delivered -1.90%, underperforming the IA Equity Income sector largely due to its bias away from FTSE 100 companies.
3. Top contributors and notable detractors to performance in the quarter.
4. Portfolio changes: Exited Essentra; initiated positions in Dunelm and Kainos.
5. Stock spotlight: Ricardo – a consultancy providing specialist technical services at the intersection of transport, energy and global climate agendas.
Downing launches new actively managed liquid alternatives fund aiming to deliver 7% to 10%+ per annum and positive returns in most markets. The new MGTS Downing Active Defined Return Assets Fund (‘Active Defined Returns’, the ‘Fund’), is the first fund from its new Liquid Alternatives team.
The Fund is aimed at institutional investors, Discretionary Fund Managers, IFAs and advised sophisticated individual investors, and will primarily consist of UK Government bonds and large-cap equity index options, which provide significant scalability and strong liquidity. It aims to deliver 7% to 10%+ per annum and positive returns in all markets except for a sustained equity market fall (generally more than 35%), over a period of at least six years.
The Fund is the first to be launched by the new Liquid Alternatives Team established by Downing. Collectively, the team has over 125 years of experience and sector knowledge, and includes Tony Stenning, who held senior roles at BlackRock and most recently was CEO of Atlantic House Group; Russell Catley, founder and also a former CEO of Atlantic House Group; Huw Price, a former Executive Director at Santander Asset Management, and Paul Adams, former Head of Cash Equities and Derivatives Sales, Royal Bank of Canada.
The Fund offers investors a compelling building block for multi-asset portfolios, aiming to add consistent and predictable returns, typically secured with a portfolio of UK Government bonds. The unique proposition includes a hybrid approach of using systematic derivative strategies and active management, combining liquid investments with predictable returns, and an equity like risk profile.
Investment strategy: Maximising the probability of delivering predictable defined returns across the economic cycle.
Systematic Liquid Derivatives: Systematic, derivative strategies optimise the equity risk-return profile. The Fund uses rules-based derivative strategies linked to the most liquid, large-cap global equity indices (i.e. FTSE100, S&P500) with the aim of harvesting well-proven consistent returns across a wide corridor of market conditions.
Strong security: The Fund will hold a high-quality portfolio of assets as secure collateral – typically UK Government bonds.
Active benefits: At times, rules-based, passive derivative strategies can underperform when markets move strongly – this is when specialist active management can add incremental gains by monitoring and monetising positions and applying active risk management.
Key benefits
Increased consistency and predictability of returns: Positive returns in all markets except for a sustained equity market fall of more than 35% over at least six years.
Diversification of risk: The Fund’s risk components are diversified across large, liquid equity indices, observation levels and counterparties. Secured with high-quality assets – typically UK Government bonds.
Active management: Our experienced team will actively manage the Fund and its investments to optimise risk and reward for investors.
Russell Catley, Head of Retail, Liquid Alternatives at Downing, said: “Put simply, we focus your investment risk on the probability of receiving the returns you need, not those you don’t. We target the highest probability of delivering 7% to 10%+ per annum with active management adding material incremental gains. We believe that we are building the next evolution of the proven success of Defined Returns funds
The Downing team isseeing strong demand from clients looking for alternatives to large-cap equity funds which are becoming concentrated in technology stocks, or alternatives to UK equity income funds and illiquid alternatives.”
Tony Stenning, Head of Liquid Alternatives at Downing, said: “The launch of our Active Defined Return Assets Fund is a significant milestone in the ambitious build-out of our new Liquid Alternatives strategies. It is a solution-focused fund that should deliver stable high single or low double-digit returns across a wide spectrum of equity market conditions, except for a persistent multi-year bear market. The Fund is designed to enhance balanced portfolios by providing consistent, predictable returns and is suitable for accumulation or drawdown.
“We aim to deliver a unique combination of proven systematic derivative strategies and specialist active management, and we are doing so at a very compelling fee level, below our closest competitors and in line with active ETFs.”
How the Fund is expected to perform in different markets
In bullish markets: UK Government bonds secure the capital, and the equity index options deliver a predictable 7-10%+ return per annum – giving up some less likely upside.
In neutral markets and normal market corrections: UK Government bonds secure the capital, and the index options deliver a predictable 7-10%+ return per annum.
In a sustained sell-off: if markets fall more than the cover to capital loss and do not recover for six years. Then capital is eroded 1:1 in line with the worst performing index.
The average Cover to Capital Loss is targeted at 35%: the average cover to capital loss represents the average level the Global indices within the Fund could fall before capital is at risk.
Fund key risks
Performance: Capital is at risk. Investors may not get back the full amount invested.
Liquidity: Access to capital is always subject to liquidity.
Counterparty risk: Other parties could default on the contractual obligations.
Fund Structure
UK regulated OEIC fund structure, fully UCITS compliant
Daily dealing, at published NAV
Minimum investment: £100,000
SRRI: 6 out of 7
Depositary: Bank of New York
Authorised corporate Director (‘ACD’): Margetts Fund Management Ltd.
I share-class: SEDOL: BM8J604 / ISIN: GB00BM8J6044
F share-class: SEDOL: BM8J615 / ISIN: GB00BM8J6150
Risk warning: Opinions expressed represent the views of the fund manager at the time of publication, are subject to change, and should not be interpreted as investment advice. Please refer to the latest full Prospectus and KIID before investing; your attention is drawn to the risk, fees and taxation factors contained therein. Please note that past performance is not a reliable indicator of future results. Capital is at risk. Investments and the income derived from them can fall as well as rise and investors may not get back the full amount invested. Investments in this fund should be held for the long term.
Important notice: This document is intended for professional investors and has been approved as a financial promotion in line with Section 21 of the FSMA by Downing LLP (“Downing”). This document is for information only and does not form part of a direct offer or invitation to purchase, subscribe for or dispose of securities and no reliance should be placed on it. Downing does not offer investment or tax advice or make recommendations regarding investments. Downing is a trading name of Downing LLP. Downing LLP is authorised and regulated by the Financial Conduct Authority (Firm Reference No. 545025). Registered in England and Wales (No. OC341575). Registered Office: 10 Lower Thames Street, London EC3R 6AF.
In his Q4 2024 commentary, Josh McCathie, manager of the VT Downing Small & Mid-Cap Income Fund, discusses the headwinds faced by the UK economy during the period. Josh also reviews the fund's performance, which was hurt by UK small-cap underperformance relative to large-cap. Despite the obvious challenges, he believes that UK small-caps continue to offer an appealing proposition to investors.
The final quarter of the year firmly halted the positive momentum that was building in UK small cap equities in the previous three quarters. Without wishing to get too political, we feel much of the damage to sentiment was self-inflicted. Labour’s first budget in October, and the scale of tax rises introduced, largely focused on businesses through increased National Insurance contributions. This has dented business confidence, with the Institute of Director’s Economic Confidence Index falling to its lowest level since the onset of the Covid pandemic. The Budget was delivered with the rhetoric that the public finances were in a terrible state and blame was largely attributed to previous Conservative administrations. This downbeat messaging trickled down into the real economy, with UK GDP flatlining and Q3 numbers revised down from +0.1% to 0%. However, not all is doom and gloom. Looking into the year ahead, 70% of UK businesses expect turnover to increase in 2025, up from 62% the prior year, and with real wage growth, most economists expect UK households to be better off than in 2024. Even though it was a disappointing end to 2024, we are confident that UK small caps will continue to offer an appealing proposition for investors. This is backed by their low valuations despite strong fundamentals (consensus 2025 EPS growth of >22% for the FTSE 250), and relative political and economic stability. Calls for reinvigorating UK capital markets are supportive and are getting louder, which points to potentially more upside than downside risk from here.
The fund delivered -1.90% during the period compared to -1.34% for the IA UK Equity Income sector. We were hurt by UK small cap underperformance relative to UK large caps, which the fund has no exposure to. The FTSE 100 delivered -0.18% compared to -4.21% for the FTSE Small Cap index, -2.31% for the FTSE AIM All Share and -1.42% for the FTSE 250.
The winners
Top contributors to performance in the period included building and infrastructure contractor Galliford Try, which was also a top contributor in Q3 following an upgrade to trading at its full-year trading update. In the period, the group reiterated strong momentum in underlying trading, along with announcing a further £10m share buyback programme. We believe Galliford Try will continue to benefit from increased spending on infrastructure, and more importantly, from its exposure to providing specialist engineering and test and inspection services to the regulated water industry. This whole sector is due to invest heavily in its asset base over the coming years.
Actuarial and investment consultancy, XPS Pensions Group, upgraded full-year expectations at the half-year stage despite tough comparatives from strong trading in the last financial year. Half-year earnings per share were up 53% and the interim dividend per share increased by 23%. The company said that there had been particularly strong revenue growth in actuarial consulting and pension administration business lines. This followed a period of new business wins in administration and ongoing heightened demand for advice on large corporate pension schemes in the wake of changes to funding positions in the current environment.
Other notable contributors were Zegona Communications, as it announced it expected to sell a stake in its fibre-to-the-home network by the end of the first half of 2025, which could unlock material upside for equity holders. DiscoverIE designs and manufactures customised electronic components for industrial component and is a recent addition to the portfolio. The group issued interim results showing new orders had returned to growth and operating margins had continued to progress by a further 0.9%.
The losers
In terms of detractors to performance, the most notable was travel retailer, WH Smith. Despite being the fund’s largest contributor in Q3, the position gave up those gains in Q4. During the period, adjusted PBT came in slightly ahead of consensus, however we believe the market expected an upgrade going into FY25. We believe WH Smith operates in a structurally growing market with plenty of growth levers at its disposal over the next few years. We do not believe these are reflected in the current valuation.
Foresight Group, an alternatives asset manager of infrastructure and private equity assets, issued somewhat lacklustre interim results in the period. Half-year profits grew by 5% and management maintained their guidance of doubling profits over five years. However, given the change in sequencing of future asset raising, this suggests that the doubling of profits will be more back-end weighted than previously anticipated. Despite this, most of Foresight Group’s revenues are recurring in nature based on managing long term assets, and are trading at close to 10x price to earnings ratio. This is a material discount to recent M&A activity in the sector.
Portfolio activity
In the period, the fund completed one full exit, which was Essentra. This business is highly exposed to European industrial markets which we believe may now take longer to recover than initially anticipated. We took the opportunity to rotate into DiscoverIE which we believe is more geared towards structurally growing markets. We trimmed a few positions on the back of strong performance; XPS Pensions, Bloomsbury Publishing, Supreme and Foresight Group (prior to the results announcement).
The fund initiated two new positions: Dunelm and Kainos. Dunelm is a business the fund has held previously, and we took advantage of share price weakness following concerns around the UK economy. Dunelm is a category winner and has grown significantly, largely through gaining market share as its underlying homewares market has demonstrated very little cumulative growth in recent years. Similarly, Kainos, also a previous holding in the fund, has experienced substantial share price weakness over the past 12-18 months due to delays to government contracts. Whilst it won’t happen overnight, we expect Kainos to be pivotal in enabling further efficiencies from technology within public services. In the meantime, the business is very cash generative and is carrying out a £30m share buyback programme.
Stock spotlight - Ricardo
Relatively short spotlight this quarter, but we would like to highlight Ricardo and the companies’ agreed disposal of its Defence division, which was announced in December. Ricardo has been implementing a strategy of transitioning the business to focusing on environmental and energy transition consultancy and data modelling and away from legacy engineering business lines. The disposal of the Defence division is a key milestone in this journey. The proceeds will be reinvested into E3 Advisory, an infrastructure advisory firm to both governments and private clients. This pivot towards a more capital light business will free up cash to pursue further bolt-ons in growing markets compared to legacy capital intensive businesses which are somewhat ex-growth markets. Similar international businesses to Ricardo’s capital light advisory businesses trade at close to double the earnings multiple of Ricardo, and we would expect this discount to close as the transition continues with only c.£10m of the group’s £50m projected operating profit coming from legacy divisions.
Opinions expressed represent the views of the fund manager at the time of publication, are subject to change, and should not be interpreted as investment advice.
Important notice: This document has been prepared for professional investors and has been approved as a financial promotion by Downing LLP (“Downing”). Capital is at risk and investors should note that their investments and the income derived from them can fall as well as rise and investors may not get back the full amount invested. Past performance is not a reliable indicator of future performance. Any subscription to the fund should be made on the basis of the relevant product literature available from Downing, and your attention is drawn to the charges and risk factors contained therein. Downing does not offer investment or tax advice or make recommendations regarding investments. Downing is a trading name of Downing LLP. Downing is authorised and regulated by the Financial Conduct Authority (Firm Reference No. 545025). Registered in England No. OC341575. Registered Office: 10 Lower Thames, London, EC3R 6AF.
.jpeg)
