Rockwood Strategic (RKW ), the UK micro-cap trust run by Richard Staveley at Harwood Capital, has recovered from the brink of wind-up 18 months ago to deliver a sector-leading performance helped by the takeover of its largest holding, which has left a cash pile the manager is carefully re-deploying.

The £50m UK smaller companies trust was born out of Gresham House Strategic. After the ousting of the manager Gresham House in favour of Harwood Capital, the former manager used its position as the trust’s largest shareholder to force the company into a two-year wind-down. However, a last-minute decision to sell the stake meant Harwood boss Christopher Mills was able to relaunch the investment trust and bring back Staveley as manager.

Staveley joined Gresham House in September 2019 to run the Strategic portfolio but left after 20 months after a dispute on how to grow the portfolio.

Despite Staveley leaving the fund for a six-month ‘gardening leave’, he said every stock in the concentrated portfolio of just 18 stocks was picked by him.

A full-year trading update this month showed that over the 12 months to 31 March Rockwood’s total investment return jumped 21.4% in contrast to the steep declines in the FTSE Small Cap index of 15.7% and FTSE AIM All Share of 22.4% as small-cap stocks were dumped as markets took fright of rising interest rates and a darkening economic outlook.

Total shareholder returns over the period totalled 28.2%, with the £110m acquisition in December by Aggreko (AGK) of Crestchic, the power testing equipment manufacturer, providing a big boost. It accounted for nearly a third of the portfolio leaving the manager currently 20% in cash to cautiously reinvest in further special opportunities. 

Over three years, the trust’s net asset value (NAV) has grown 116.9% and the total shareholder return by 139.4%, ranking the it number one in the AIC UK Small Companies sector over both 12 months and three years.

In a structure that our columnist David Stevenson would approve, judging by his article on performance fees this week, Rockwood pays Harwood a fixed annual fee of £120,000. This is topped up by a performance fee of 10% of NAV gains over a 6% annual hurdle, meaning the forthcoming annual report should detail a big payment for Staveley (below) and his colleagues.

It is the only trust in its sector to register a gain over the past year and Staveley said the ‘very concentrated approach’ is the reason why, as it allows him to ‘find a handful of stocks that will do something different’ to the index.

Value and recovery plays

There are two types of stock in the fund: springboards which are weightings of up to 4% and core holdings that are above 4% and as high as 10%, although almost all are under £100m of capitalisation, and some less than £30m.

Staveley said at this level the larger fund managers ‘have too much money to invest so do not bother even looking, even if some look like a great investment’, making small-caps a ‘very inefficient market’.

As well as looking at the unloved part of the market, Staveley believes he sets himself apart by hunting out stocks that are ‘value and recovery’ plays, which he said is a ‘big competitive advantage’.

He said most fund managers cannot be bothered to look at the bottom of the market but when they do they are looking for ’10-baggers’ – a stock that can deliver a 10-fold return – whereas he is ‘happy to find a small company that is very niche but maybe has made a few bad strategic decisions but that we can see can double in value’.

RM’s painful lesson

The fund’s biggest position falls into this category: RM Group (RM), which made up 11.1% of the portfolio at the end of March, provides education supplies such as textbooks, as well as providing services such as technology systems and complex teaching aids.

Staveley bought a stake in the company – which sells to 90% of the UK’s primary schools – late last year, after it ran into a serious systems problem.

‘RM has been around on the stock market for 20 years and last year it got into a pickle because it rolled out a software system and it went wrong, and as a result it did not know where stuff was meant to be, and it underperformed for clients, and had to get very expensive consultants in to sort it out. This pushed the debt up and it missed profit,’ said Staveley. ‘All that was during a difficult year, and it got punished heavily.’

While the shares are up 30% year-to-date, they are still down 44% over one year and 62% over five years.

Staveley said the company’s market value had fallen to just £26m when he bought shares last year despite generating sales of £200m.

‘Since then, it has more than doubled and just under £70m market cap and we built stake of 10% in the company because we think that the business is worth £180m, so at least double again,’ he said.

‘It has a new chief executive and there has been a board evolution, and we are encouraging it to dispose of non-core assets to pay down debt to help with revaluation.’

City Pub

Another undervalued ‘springboard’ stock for Staveley is City Pub Group (CPC), the brainchild of Clive Watson, who built and sold Capital Pub Company to Greene King for £70m in 2011.

Staveley said City Pub floated into the bull market to ‘much excitement’ with the shares trading at 25-30 times earnings, but ‘a combination of Covid-19 and the cost-of-living crisis’ forced the company to slow its growth rate, causing the shares to lose almost half their value over the past five years.

However, Staveley said nearly two-thirds of the pub portfolio is freehold in prime locations and ‘the last independent valuation valued [the portfolio] at £150m but people are not paying too much attention, and the value of the market cap is just £86m’.

‘We think the market cap can grow to £150m-£200m,’ said Staveley.

Cautious outlook

However, while Staveley has reinvested around a third of the cash from the takeover, he said ‘because of the way the markets are we are not rushing’.

‘I think the market is going to find it difficult to make material headway from here until interest rates start coming down in non-crisis way,’ said Staveley.

While there is ‘some rock bottom stuff’ in the valuations of UK smaller companies, and the UK market as a whole is cheap versus other global markets and history, he said ‘this is not the market to rush into’.

The trust itself is included in the cheap stocks, running at a discount of 7% to net asset value, which Staveley said is ‘even higher’ on a ‘look through’ basis given the high cash weighting.