Fund Manager Focus

Fund management house Knox D’Arcy took over the underperforming Eaglet investment trust earlier this year after being approached by majority shareholders. Since then it has realised just over half of its assets at a premium to asset value.

Director deals signal value The transformed trust’s strategy is to invest in stocks where directors are buying their own shares – a very visible trend among unloved small caps of late – since such trades typically, though not always, shine the light on value.

Howard explains, ‘The premise is that directors know more than the rest of the market and therefore (shares in these companies) should outperform, and this has been verified by independent research.’

Knox D’Arcy has developed its investment process using a combination of trading strategies, which have been tested under various market conditions.

Howard, and the team responsible for running the fund, have created a database of director dealings over the last 14 years, looking at over 182,000 trades, to help formulate this process.

He says, ‘Based on historical analysis, the process has outperformed in terms of the number of positive outcomes following directors’ deals, as well as the margin of outperformance.

‘Looking specifically at the small-cap indices over the last seven years, the process has identified an average of 58 per cent of positive investment calls, with the winning calls substantially outperforming the losers on a one-to-one basis.’

The size of the fund has initially been set at approximately £50 million with a minimum of 40-60 holdings, however Howard believes that the fund could easily grow larger. ‘The beauty of this strategy is that it is scaleable,’ he enthuses. ‘There’s no reason why it shouldn’t be a £500 million or £1 billion fund.

‘The real value is in identifying the “buy signals”, as there are various circumstances when directors buy shares in their own companies.’

Howard points to £20 million cap Telford Homes as an example: ‘Directors have recently been buying shares in this East London-focused residential developer. Since 15 July, the shares have risen from 69p to 90.5p, representing a rise of 31.2 per cent compared to an increase in the index of 20.3 per cent over the same period.’

However, as he explains, a stock doesn’t make it into the fund simply because a director has bought shares. Take AIM-quoted housebuilder Oakdene Homes. This had just one single purchase recorded since early March, but it wasn’t included in the fund.

‘What people don’t realise is here are nine different types of director purchase, from when a director simply pulls out a chequebook or makes a gift to a family member, to a rights issue or buying for a PEP or ISA, not all of which will have a positive impact on the share price.

‘We take the time to look at exactly what has motivated the director to buy shares and also compare the types of directors involved. For example, we find out if they are junior executives or senior directors or non-executive directors.’

Howard concludes, ‘This is not foolproof. We have adopted a portfolio approach to this instead of finding which directors have been buying in company X and then just buying into that particular company, as the latter approach could probably lose you money. You have got to play different strategies and question why this is happening, if you want to make money – statistically however, the fund is a safe bet.’