Henderson Opportunities struggles in difficult year for small caps

Henderson Opportunities says its Net Asset Value total return for the year ended 31 October 2016 was 0.4%, while the UK market returned 12.2%. Its discount widened significantly over the course of the year, to stand at 17.5% at the year end. The total dividend for the year is 19.00p an increase of 5.6% on the previous year.

The managers point out that smaller companies (where the fund is overweight relative to the UK market as a whole) underperformed larger ones in the year to 31 October 2016 as weaker sterling disproportionately favoured larger companies. This has led to undemanding valuations for many smaller companies so they now expect this underperformance to reverse.

They also say that some of the fund’s most successful investments, such as Senior, gave back ground this year despite continued positive trading news but they believe that they will add value in the future.

The section of the report that describes the five largest detractors from performance is reproduced below:

Oxford Pharmascience, a drug development company, specialises in the application of proprietary formulations to make existing approved drugs more tolerable with lower side effects. The focus has been on the over the counter pain relief market. Initial trials delivered promising results so the company has had numerous discussions with large pharma about out licensing deals. However, it has become clear that the trials process will be much longer and more costly before the hoped-for deal can be signed. The company is well funded but timelines have shifted materially out. We decided to sell part of our position to recycle the money into better ideas.

Vertu Motors, the UK’s 5th largest motor retailer, was in our top 10 last year. We subscribed to a share issue early in the year to fund the acquisition of another dealership. The company has traded well but the market is concerned that an economic slow-down would reduce consumer confidence and that the fall in sterling would hit demand for imported vehicles and squeeze margins. But though the demand for new cars is economically sensitive, changes in car financing in the last ten years mean that motor retailers make most of their money from servicing and second hand sales. Vertu is very well financed so has the capacity to weather any storm.

hVIVO, previously Retroscreen Virology, a provider of bio-medical services, was also a top 10 position last year. It saw its underlying market retract as large pharma clients diverted resources to tackle the Ebola outbreak. It shifted its strategy to encompass more investment in its own product portfolio and this has raised the annual cash burn. We have reduced our exposure.

We had great hopes for Lakehouse, the asset and energy support services company, which had an IPO in 2014. It had the opportunity to consolidate a fragmented sector but the management team behind the IPO proved to be not up to the job. The company took on business in areas it had little experience of and inevitably paid the price. Forecasts were not met and management left. Bob Holt, previously the CEO of Mears plc and its current Chairman, is now CEO and we are hopeful that this effective operator can focus Lakehouse back on its strengths and return it to growth.

IP is a long term holding which partners with universities to exploit innovations coming out of their research departments. It had a disappointing year in share price terms as the hoped-for IPO of its largest investment, Oxford Nanopore, has not yet happened and investors have become more averse to risk. IP is well-funded and has an exciting future so we are holding this position for the long term.”

The top five positive contributors to performance:

In a difficult year for IPO’s we invested in Blue Prism, a small software developer involved in the emerging market for robotic process automation. Their business model is cash generative once scale is reached and contracts are typically for 3 to 5 years, having started with a small pilot. Growth rates have been strong and recent moves into the USA have been well received. The share price has more than trebled since the float so we have taken some profit but it continues to be a core position.

Micro Focus is now a FTSE 100 company and is at the other end of the maturity curve. Legacy enterprise software may not have any growth, but, managed in the right way it is highly cash generative with very loyal clients. Acquisitions have been a key feature of the company’s growth, the latest being the largest yet, the acquisition of HP Software, which includes what is left of the old Autonomy business. This transaction will complete later in 2017 so we expect the shares to consolidate until the significant potential benefits are more visible.

We sold out of Glencore, which performed very well for us, but it was still our third largest contributor in the year. 

RWS, the patent translation services company, listed on the AIM market in 2003 and we have been a long term investor. The company has an unbroken record of profitable organic growth supplemented by astute acquisitions which have broadened and diversified the business. Most recently, it bought CTi, a US based market leader in life sciences translation and linguistic validation. The company generates cash and has grown dividends materially over time. We view this stock as a core holding.

Lastly, Keywords Studios is a global leader in services to the video games industry. It has grown rapidly in the last two years both organically and by acquisition. The range of services has been extended since the float in 2013, which was poorly received but our faith in the management has been vindicated. This year has seen good earnings upgrades and a significant rise in the rating. We have taken some profit but see the longer term opportunity as very large.”

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