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Questor: these trusts are betting heavily on their top stocks – should we be worried?

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fibre optic cables
fibre optic cables

The explosive gains delivered by shares in Volex, the cable maker tipped by this column three years ago, will be familiar to regular Questor readers. Their role in the performance of one of this column’s investment trust picks, Downing Strategic Micro-Cap, may be less well known.

Shares in the trust have gained 24pc since Questor advised readers to buy them in July 2019, a creditable return given that the FTSE 100 has lost 5pc over the same period.

But Nick Hawthorn, a fund manager at Downing, provided this column a greater service when he highlighted Volex’s potential a year earlier. Since Questor tipped it in August 2018, the shares have quintupled, the best return of any of this column’s stock picks since its relaunch five years ago.

Such is Hawthorn’s enthusiasm for the shares that they occupy a sizeable portion of Downing Strategic Micro-Cap’s portfolio: 17pc at the end of August. It is this unusually large position that has attracted Questor’s scrutiny.

Regular readers will remember that this is not the first time one of our trust picks has featured such a large holding. In March 2019, Questor advised readers to sell shares in European Opportunities because we were uncomfortable with the manager’s 16pc position in Wirecard, the German payments company then accused of financial wrongdoing in a series of articles by the Financial Times.

Only once that stake had been reduced did this column renew its “buy” recommendation – regrettably so, given Wirecard’s eventual demise.

Given our stance on the size of the original Wirecard stake, Questor’s position on the Downing trust needs some explaining. While there is clearly a similarity between the two situations, there are also some crucial differences. The first is that European Opportunities is a much more mainstream fund, which made its strikingly large Wirecard position all the more difficult to stomach.

A trust that invests across Europe’s stock markets is likely to occupy a larger position in investors’ portfolios than one, such as Downing’s, focused on the very smallest firms listed in London. Holding so much of investors’ money in a single stock can therefore have greater consequences should the bet turn sour.

The second is concerned with the companies that are – or rather were, in Wirecard’s case – the subject of these bets.

Volex is a business in which Questor sees continued potential, which is why this column has recommended readers continue to hold the shares, even after their extremely strong run. Wirecard, by contrast, was not only never tipped but had attracted a string of negative stories, vindicated by its collapse.

Questor also takes some comfort from the profits the Downing trust’s managers have already banked on their Volex position. After investing £5.5m in the shares in 2018, they have sold £8.4m worth as they have risen in value and now retain a stake worth £8.2m. The trust remains a concentrated portfolio, housing just 14 companies, but positions are not being allowed to run unchecked.

Another more recent Questor trust pick deserves mention in this context. Chrysalis Investments, tipped in June, harbours an even larger holding, of 25pc of its portfolio, in the Swedish payments company Klarna.

Like the Downing trust, Chrysalis is not a mainstream fund likely to form the backbone of investors’ portfolios, and neither would Questor advise readers to treat it as such.

Its investments, in a small collection of private European firms, are much more specialist. This type of investing leads to fund managers having less control over the size of their positions than they would in more mainstream funds that stick to quoted shares.

Chrysalis’s position in Klarna illustrates this: it nearly doubled in the first half of this year after two funding rounds that valued the company at successively higher valuations. Banking profits here is not as straightforward as selling shares on the stock market.

The risks should not be downplayed but, at a suitably moderate size in portfolios, trusts such as Chrysalis provide some compensation by giving access to investments that would otherwise be out of reach. We’ll hold both the Chrysalis and Downing trusts.

Questor says: hold

Tickers: DSM, CHRY

Share prices at close: 77.75p, 224p

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