Fund Manager Focus by Ellie Duncan

Conor McCarthy is a great believer in the outperformance of the small-cap sector, and feels it’s the only sensible place to invest at the moment. Co-manager of the MFM Techinvest Technology Fund, which launched in 2003 and is co-managed by Darren Freemantle, he is focused on technology-centric small-caps on both sides of the Atlantic.

McCarthy says that the technology sector is often perceived as high risk by retail investors and acknowledges that individual stocks can be volatile.

‘The tech sector goes through periods of excessive exuberance and optimism, and the high-tech boom that culminated in early 2000 was perhaps the most spectacular.’

McCarthy is referring to the dotcom bubble that burst rather abruptly about ten years ago following what many analysts and fund managers believe was a period of over-investment in much-hyped technology stocks. There were 35 specialist technology funds in the UK at the peak of the boom, compared with just 11 IMA Technology and Telecommunications funds now.

Over the past five years, for every £1,000 invested on a total return offer-to-bid basis, the fund has made £261, below the IMA funds average of £446.

Blinkx and you’ll miss it
The fund’s geographical bias has switched in recent years in response to the US’s dominance in the technology industry.

Says McCarthy, ‘In the early years of the fund, we were 75 to 80 per cent invested in the UK, but in 2007 we began to steadily increase the percentage we were investing in North American stocks. There’s a far greater population of tech stocks in the region.

‘The other difference between the UK and the US is the degree of liquidity. The small-cap sector in London has become quite to very illiquid over the past five years. It is easier to get in and out of stocks in North America relative to getting in and out of smaller-caps in London,’ he claims.

The Techinvest Technology Fund’s top holding is UK-based video search company Blinkx, accounting for 5.8 per cent of the fund’s weighting.

‘We took a position at its initial public offering (IPO), when it was being spun out of Autonomy. Even then, Autonomy was clearly the best managed tech company in the UK.’

McCarthy also cites the business’s ‘highly regarded’ chief executive, Mike Lynch, who retained a 20 per cent stake in Blinkx. At the time the fund invested it was a loss-making company, but by May 2010 Blinkx had reported a small profit.

‘Key for us was the fact that Blinkx had become cash generative. We very rarely invest in a company that doesn’t have positive net cash on its balance sheet. Most tech companies, particularly in the US, have huge amounts of cash. In that sense, maybe we are risk averse.’

Value stocks
The fund’s second-largest holding is in Miranda Technologies, which accounts for 3.8 per cent of its weighting. Based in Canada, the company specialises in broadcast equipment, which it sells to cable and satellite businesses.
McCarthy maintains that it is ‘the most undervalued stock’ in the portfolio, with a single-figure p/e ratio and ‘plenty of cash’ on its balance sheet. However, he remains wary of ‘value traps’.

‘In other words, companies that have good assets and plenty of cash but they don’t seem to be doing enough to lead you to believe that they could become a growth story in the near term.’

He explains that it’s about identifying the businesses offering value and realistic growth prospects in a few years’ time.

McCarthy is optimistic about the future of the technology sector: ‘The sector represents a unique investment proposition that has considerable growth prospects over the next three to five years, and that’s backed by very strong, cash-rich balance sheets. I can’t think of any other sector in the market that has such an appealing combination.’