Odyssean Investment Trust — Focused approach to UK small-cap investing

OIT is a new, closed-ended investment trust, incorporated in England, listed on the premium segment of the Official List of the UK Listing Authority and admitted to trading on the London Stock Exchange as of 1 May 2018, with an initial market capitalisation of £87.5m. The trust’s investment objective is to generate attractive, long-term capital growth through investing in UK smaller companies, primarily those with market capitalisations of between £150m and £750m. Managed by Odyssean Capital, it follows a hybrid public and private equity investment approach in its search for companies that are trading below intrinsic value, in which the manager can invest an influencing stake to allow it to engage with stakeholders to help improve value over a three- to five-year horizon. Once fully invested, the portfolio should consist of 20–25 stocks, with the top 10 holdings accounting for the majority of the fund’s net asset value. The investment process is relatively unconstrained and benchmark-agnostic, although the Numis Smaller Companies ex Investment Trusts plus AIM index is used as the comparator for determination of a performance fee.

The trust has the ability to borrow up to 10% of net assets for investment purposes; however, there is no intention to use gearing or derivatives at present. The manager anticipates typical cash balances to be around 8–12% over the long-term, to enable OIT to have investment flexibility and avoid being a forced seller of investments.

Odyssean Capital (Odyssean) was launched in February 2018 and is a joint venture between Stuart Widdowson and Harwood Capital Management Group, each owning 50% of the company. Mr Widdowson was the lead manager of SEC for seven years until he resigned in February 2017 to found Odyssean.

Harwood Capital Management Group was founded by its CEO, Christopher Mills, in 2011 as an independently owned group of investment companies. He and his team manage a number of public and private funds, most of which follow an active value approach. The group also has a real estate investment business, manages a number of private client portfolios and has majority interests in complimentary financial services businesses. As at 31 January 2018, Harwood Capital Management Group had around £4.4bn of funds under management. Mills and Widdowson have known each other for more than a decade, and Mills believes Odyssean and Widdowson will bring a complementary skill set and distinctive investment strategy to the group. The organisation structure of Odyssean is shown in Exhibit 2.

Odyssean has a four-member management committee and has appointed Ian Armitage as its non-executive chairman. He is the former CEO and chairman of HgCapital, where he and Widdowson worked together between 2001 and 2006. Armitage has over three decades of experience in small and mid-cap private equity investing and is currently chairman of education support-services company, The Key, and non-executive director of Tenzing Private Equity. Christopher Mills serves as a non-executive director on the management committee. He has invested in smaller quoted and unquoted companies for some 40 years. Widdowson is managing partner and Ryan Corton, the COO, shares the same role at Harwood Capital.

Harwood Capital provides certain services to Odyssean, including but not limited to finance, operations and compliance. This structure is favourable for the company, given Harwood’s established infrastructure and expertise, including a trader with over 15 years’ experience trading in illiquid UK-quoted stocks. This allows the investment team to focus their time on investing. The two portfolio managers, Widdowson and Wielechowski, are the key members of the investment team; Wielechowski is another HgCapital alumnus.

They are supported by a panel of advisers consisting of senior industry specialists, who will meet a minimum of nine times a year to discuss potential investee companies. The advisory panel includes Roger Siddle, the former managing partner of Bain UK, and John Poulter, a well-known UK industrialist. The team can also draw on the considerable contacts and expertise within and around the Harwood Capital Management Group.

Odyssean believes smaller companies are often mispriced and present some of the best UK-listed investment opportunities. The manager will primarily invest in smaller quoted companies, which are trading below intrinsic value and where this value can be increased through strategic, operational, management and/or financial initiatives. Having an influencing stake in a company is important, allowing the manager to engage with stakeholders to help improve value.

Small-caps have outperformed large-caps over the longer term, as shown in Exhibit 3, which compares the performance of £100 invested in the Numis Smaller Companies ex-investment trusts plus AIM index (which tracks the performance of the smallest 10% of companies by value in the UK equity market, rebalanced every year, plus AIM companies which meet the index limit size) against the Numis Mid Cap and FTSE All-Share indices. The manager believes this long-term outperformance reflects a number of factors including smaller companies being able to grow faster than larger companies; the smaller companies market being less efficient, with a smaller investor pool and more limited sell-side research; and given their size, smaller companies have attracted more acquisition interest compared to those in the FTSE 100. Widdowson anticipates that these factors will continue and also makes further observations:

Widdowson is OIT’s lead portfolio manager and brings 17 years’ investment experience in public and private UK small and mid-size corporates, and a further two years providing investment advisory services in the same field. Widdowson was previously the lead manager of GVQIM’s award winning investment trust, SEC. During his tenure, in the period from 30 June 2009 to 31 January 2017, SEC delivered a NAV total return of 377% and a share price total return of 508% compared to total returns of the FTSE Small Cap (ex investment companies) index of 204%, and the Numis Smaller Companies ex-investment trusts plus AIM index of 174%. Between 2001 and 2006, Widdowson was associate director at private equity investment company, HgCapital, where he worked on small and mid-cap leveraged buyouts in the UK and Germany, including helping private companies to acquire public companies. He began his career as a strategy consultant, undertaking commercial due diligence and strategy projects for private equity and corporate clients.

Edward Wielechowski joined Odyssean in December 2017 and has over 11 years’ investment experience. Most recently, he was principal in the technology, media and telecom (TMT) team at HgCapital. His responsibilities included sourcing, evaluating, executing and managing investments in the TMT sector in UK, Europe and the US. His public market experience includes several successful public-to-private transactions, and he led the IPO of Manx Telecom in 2014. Between 2004 and 2006, Wielechowski was an analyst in the UK mergers and acquisitions department at JPMorgan Cazenove.

The manager is focused on UK-listed companies too small for inclusion in the FTSE 250 index (the current threshold is c £800m market capitalisation), but typically larger than £100m at the time of purchase. The manager’s investment team will look to invest in six sectors: technology, media and telecom (TMT), industrials, healthcare, services, financial services, and consumer. The manager does not intend to invest in resources, nor in certain financial services companies such as banks and insurance companies, as it believes business models within these sectors are more reliant on factors that are difficult to analyse or predict (for example commodity prices and interest rates). The team’s preference is for companies with prospects for structural, non-cyclical growth. The focus on fundamental value and quality means highly rated, high-growth momentum stocks are unlikely to feature in the portfolio, and therefore OIT may underperform when these types of stocks are ‘in vogue’. Three types of investment situations tend to present the most interesting opportunities: i) self-help companies, which are generating returns below their potential that can be addressed through engagement; ii) reasonably priced growth companies that are attractively valued because they have been overlooked, with re-rating potential; and ii) “fallen stars” which are typically good companies, former growth/momentum stocks that traded on very high valuations, but de-rated sharply following investor disappointment. Drawing on the investment team’s considerable public and private equity experience, the investment process contains five key elements:

Odyssean’s approach to portfolio construction is a hybrid between typical equity funds and private equity funds. As shown in Exhibit 4, once fully invested, the portfolio should be significantly more concentrated than most equity funds, holding larger position sizes and reflecting the importance of management engagement to Odyssean’s investment approach. The manager expects OIT to hold 20-25 investments, with position sizes ranging between 2% to 20% of the portfolio, and a maximum initial size of 15%. Average cash holdings are likely to be around 8-12%, to allow the manager to take advantage of opportunties without forcing the sale of relatively illiquid investments.

More similar to private equity funds, OIT has an absolute return approach to investing, focusing on a few sectors but with in-depth due diligence and engagement with managements of companies. The manager aims for OIT to be c 75% invested in around six months, and fully invested after one year. Once fully invested, it anticipates OIT to make four to five new investments each year.

Exhibit 5 shows a selected peer group of funds investing in UK small-cap equities. Although OIT is a member of the AIC UK Smaller Companies sector, the mandates within this vary widely and many have investment strategies that tend to be highly scalable, and therefore are not directly comparable to OIT’s portfolio concentration and hybrid public and private equity investment approach. Among the selected peers, performance fees are prevalent, reflecting the specialist nature of the strategies, which are typically less scalable. OIT has a size limit of up to 250m shares, as the manager believes a capped fund is best suited to its investment strategy and more attractive to a high quality, stable investor base. The discount/premium to NAV among this group ranges widely. OIT’s board is committed to managing the trust’s rating and has the ability to issue and repurchase shares, where appropriate. Furthermore, shareholders have the opportunity to exit every seven years at NAV less costs. OIT’s estimated annual ongoing charge of 1.6% is towards the lower end of the selected peer group range; however, some of the non-management costs are fixed – therefore, as the trust grows towards its maximum size of 250m shares, the ongoing charge should reduce over time. The trust will also likely rank towards the bottom of the group for dividend yield, at least in initial years, as it is focused on capital growth.

OIT has raised £87.5m, and has the authority to run a placing programme from 2 May 2018 until 25 March 2019. The programme is flexible and may have a number of closing dates, with the intention to satisfy market demand for shares and enhance the NAV through issuance at a premium to the prevailing cum-income NAV. Growing the company will also benefit shareholders by spreading operating costs over a larger capital base, thereby reducing ongoing charges. The maximum number of shares permitted to be issued under the aggregate of the initial issue and placing programme is 200m (the absolute maximum number of issued shares permitted is 250m).

OIT has a single class of share (ordinary) with a launch price of 100p. The opening NAV per share of c.98.4p is the opening value less costs. Initial issue costs charged to the trust were capped at 2.0% of gross proceeds.

OIT has the ability to borrow up to 10% of NAV at the time of drawdown, however, it does not intend to use gearing for investment purposes, although may utilise borrowings for short-term working capital. The trust also does not intend to use derivatives.

There is no formal discount or premium target, however, the board has the ability to manage the supply of and demand for the shares. Every seventh year after the listing, shareholders can elect to realise the value of their investment at the prevailing NAV, less costs. If OIT exits an investment as a result of a corporate action (such as a takeover), the board intends to make at least 50% of the gains available for share repurchases, provided that the shares have traded at an average discount of wider than 5% in the 60 days preceding the exit. The board will also consider share repurchases in the market, if it believes it to be in shareholders’ interests, as a means to correct imbalances between supply and demand for the shares. The board also has the authority, renewed annually, to repurchase up to 14.99% of ordinary shares outstanding. In the event the shares trade at a significant premium to NAV, the board has the ability to issue new shares as discussed above.

Odyssean Capital will receive an annual management fee, paid quarterly, equal to the lower of 1.0% of the NAV; or 1.0% of the trust’s market capitalisation. The target ongoing charges ratio, at £87.5m fund size, is around 1.5%. An annual performance fee of 10% is payable on returns more than 1.0% above the comparator index1 on a rolling three-year basis, with a high watermark. Half of the performance fee will be paid in shares if OIT’s shares are trading at a premium, or will be used to purchases shares if OIT’s shares are trading at a discount to NAV. These shares will be held for no less than three years. Performance fees payable will be capped at 1.75% of NAV in any one year, with the excess fee deferred to another year when this cap would not be breached.

OIT’s primary objective is to achieve capital growth through investing in smaller companies, likely focusing on investing for future growth rather than payment of dividends. The board does not expect OIT to pay material dividends.

OIT has a fully independent board consisting of four members. Designed to align directors’ interests with shareholders, the directors will invest c £660k in buying OIT shares at the launch, and all non-executive directors’ fees, net of tax, will be used to buy shares in the trust, to be held for a minimum of three years.

Jane Tufnell (chairman) is currently senior independent non-executive director of Diverse Income Trust, and a non-executive director of JP Morgan Claverhouse Investment Trust. She joined Country NatWest in 1986, where she managed pension fund exposure to UK smaller companies. In 1994, Tufnell co-founded Ruffer Investment Management and served on its management board until retiring in 2014.

Arabella Cecil is head of fund investments at Syncona. In 2012, she co-founded BACIT, which became Syncona in 2016. She started working in financial services in 1987 in Milan and Paris before joining CL-Laing in London, where she was head of food manufacturing research. Between 1998 and 2008 she owned and ran Gravity Pictures, which specialised in filmmaking in the IMAX format. Most recently she was an investment manager and a member of the investment and risk committees of Culross Global Management.

Peter Hewitt is the investment manager of F&C Managed Portfolio Trust, which he launched in 2008 and director, global equities at BMO Global Asset Management. Hewitt has 35 years investment management experience. He joined Ivory and Sime in 1983 managing US equities, then moved to UK smaller companies from 1987-1992. He then focused on management of UK pension fund accounts until 1996. After four years at Murray Johnstone as head of UK equities with a focus on UK income funds, he re-joined Friends Ivory and Sime in 2000 and specialised in management of investment trust funds and products.

Richard King is a director of GYG, a partner at Rockpool Investments LLP and serves on the advisory board of Frogmore Property Group. He is also chair of trustees for the Willow Foundation. King spend 35 years with Ernst and Young and was deputy managing partner of UK and Ireland and a member of both the Europe, Middle East, India and Africa board and global management group.