Staying focused

Launched in May last year as a highly concentrated global equity fund, SKAGEN Focus is very much a positive reminder of SKAGEN's roots of contrarian, high conviction investing in lesser-known companies.

Its emphasis on valuation is demonstrated by Focus currently trading at the lowest P/B ratio relative to all our funds' respective benchmarks with the fund's top ten holdings valued at 1.2x book value compared to 1.9x for the MSCI All Country World Index. Focus also has the highest Active Share of all SKAGEN funds with 98% of its portfolio differing from the benchmark.

It helps that the Lead Portfolio Manager of SKAGEN Focus, Filip Weintraub, is no stranger to SKAGEN's long-standing investment approach. Alongside Kristoffer Stensrud, the Swede helped to craft SKAGEN's '3Us' philosophy as the Lead Portfolio Manager of SKAGEN Global between 2001 and 2010. During this time SKAGEN Global delivered annualised GBP returns of 20.6%, 16.0% better than its benchmark and outperformed in seven of eight calendar years.

Small is beautiful

Focus and Global both enjoy an unconstrained global mandate and employ the same investment philosophy and process as our other equity funds, which has led to some shared holdings (AIG, for example, is the largest position in both portfolios). However, there are important differences between the two funds. As its name suggests, Focus is concentrated on a smaller number of holdings – currently 36 compared to Global's 48 – which means that the portfolio managers can back their highest conviction ideas to maximise returns albeit with the likelihood of higher volatility.

Focus also has a bias towards small and mid-cap companies, which currently represent 61% of the portfolio. Equity markets are often at their most inefficient at the smaller end of the scale where companies typically generate a wider dispersion of returns than larger ones, creating further opportunity to generate excess rewards from picking the winners. The Focus team has enjoyed great success with smaller companies over their careers.

Value and small-caps underperformed in H2 2015

Source: MSCI

Unfortunately, the first six months were tough for Focus. A weakening Chinese economy sparked a sustained period of heightened volatility with stock prices driven more by macro and market sentiment than company fundamentals. Investors sensed greater safety in larger, more expensive growth stocks and both value and small-caps underperformed as a result (see chart). The fund's relative performance was further impacted as fears over China reverberated across Asia where Focus had 28% of its portfolio invested, compared to 17% of the index, and also negatively impacted the Financials sector, where Focus was also overweight. These headwinds caused an almost perfect storm for Focus and contributed to the fund underperforming its benchmark by a disappointing 8.6% in 2015.

2016 recovery

Much like when SKAGEN Kon-Tiki was launched into a market maelstrom in 2002, Focus stuck to its strategy and has emerged stronger as a result. Assets under management have steadily grown to £100 million and performance has improved significantly with the fund delivering 12.1% for GBP investors so far in 2016.

The fund has been helped by a reversal in the market forces which hurt the portfolio in 2015 – value has outperformed growth by 1.6% and small-caps have beaten large-caps by 2.07% so far in 2016 – but Focus has benefitted most from the fund managers' careful stock selection. They invested in only two commodity companies at launch – Pan American Silver and South32 – both identified as having sufficiently strong business models and balance sheets to withstand the pressure from falling raw material prices that we saw last year. Although neither company was immune from the sector sell-off, they have both rebounded strongly in 2016 to be among the top five fund contributors, boosted by recovering commodity prices and operational improvements. Canadian copper producer First Quantum Minerals was added in October, soon doubled in value and is another of the fund's winners this year, driven by strong production results. Away from commodities, impressive operational performance has propelled Air Asia into second place among the top five performers, while Haitai Confectionery & Foods completes the list.

Haitai's IPO sweetener

Despite our general aversion to IPOs, we invested in Seoul-based, snack-maker Haitai's flotation last month. Despite the share offering being heavily over-subscribed, our strong Korean links ensured we received a large allocation of the stock which proved to be as popular as the company's Honey Butter Chips – the share price more than quadrupled to hit our price target before we sold out. Although only part of the fund for a few days, Haitai contributed GBP 1.3 million.

Following impressive returns – the three commodity producers combined have contributed 5.37% to the fund's GBP return in 2016 – Focus has reduced its exposure to the sector, including exiting completely from Pan American Silver, to limit risk and reinvest the profits into more attractive investment opportunities. These include recent portfolio additions, Philips Lighting, which we expect to benefit as investors begin to recognise LED growth prospects and Teva, the undervalued Israeli drug-maker.

Hidden gems

SKAGEN Focus currently has the highest upside potential of our equity funds at 85% based on the portfolio managers' price targets (the fund will only invest in companies with the potential for a 50% return over a 2-3 year investment horizon). A significant proportion of these returns are expected to come from lesser-known companies in which Focus has taken significant positions. For example, one of its largest holdings is Brazilian meat producer JBS, which is expected to more than double in value, driven by acquisitive growth and the return of cash to shareholders as it de-levers. More still is expected of the fund's fifth largest position, SBI Holdings, whose shares are forecast to appreciate by over 150% as recognition grows of the Japanese conglomerate's earnings power and the value within its biotech division.

The fund is well-diversified by company size, geography and sector. While still the largest sector, its Financials exposure has been reduced from 30% at the year-end to 24% at present. Focus has avoided European Financials given the risks from increasing regulatory capital requirements and the holdings, which are diversified across insurance and banking, are well-positioned to benefit when interest rates begin to rise.

While a concentrated portfolio, particularly one tilted towards small and mid-cap companies, is likely to exhibit short-term fluctuations, so far the fund has been less volatile than the index. Its highly active approach means that it could provide meaningful alpha and diversification benefits when combined with other funds. Following its recent strong returns, our hope – and that of the growing number of investors in the fund – is that the fund's focus on finding the best companies at the most attractive prices will continue to be rewarded.

All figures as at 30 June 2016 in GBP unless otherwise stated