Micro-cap be nimble, micro-cap be quick: How the Miton UK MicroCap Trust strategy is simply different

Gervais Williams and Martin Turner

Miton UK MicroCap Trust Managers

For information purposes only. Any views and opinions expressed here are those of the authors at the time of writing and can change; they may not represent the views of Premier Miton and should not be taken as statements of fact, nor should they be relied upon for making investment decisions.

Investing involves risk. The value of an investment can go down as well as up which means that you could get back less than you originally invested when you come to sell your investment. The value of your investment might not keep up with any rise in the cost of living.

Premier Miton is unable to provide investment, tax or financial planning advice. We recommend that you discuss any investment decisions with a financial adviser.

Globalisation in action

Globalisation can be defined as an economic period when global supply in traded goods is so plentiful that it exceeds demand. It causes downwards pressure on global inflation, nicely offsetting any inflation in local services.

During times of crisis such as the 2007/8 global financial crisis, consumer and company demand can be boosted through the creation of an excess supply in traded goods, through interest rate cuts and the creation of additional demand through programmes such as Quantitative Easing. Please see our glossary of key terms to learn more about Quantitative Easing.

The overall effect is that nearly all asset prices have gone up in value for years, in part due to additional economic growth during globalisation, and in part due to asset valuations rising and rising as bond yields moved to ever lower levels. Furthermore, as borrowing becomes ever cheaper through lower interest rates, most governments, companies and consumers scale up their consumption, which is reflected in rising profit margins as well; they have reached exceptionally high levels recently.

And closer to home

Many UK equity portfolios have generated attractive returns for clients over the last few decades. In general, those looking to generate the best returns have scaled up their level of risk and often outperformed.

We worry that such strategies carry additional risk as we move beyond globalisation’s hay-day and are at risk of delivering disappointing returns for investors. As their return is reliant on capital growth driven by market movements, the downturn is often accompanied by a large proportion of investors selling assets all together, amplifying the downside for investors investing on a longer-term basis.

Taking an active interest

Genuine active management isn’t just about maximising the positive periods of return, but also managing periods where there are falls in markets, so that returns have a good chance of being less reliant on stock market appreciation, and more resilient to stock market setbacks over the longer term.

Both factors (maximizing the upside and minimizing the downside) have the potential to add value for investors, but when adverse risks are present, we hope that our investment strategy will continue to have a good chance of delivering positive returns, whereas others might be more vulnerable to market risks and major financial events.

In what specific ways does the Miton UK MicroCap Trust strategy differ from others?

In contrast to many other UK small and micro-cap investment vehicles, our strategy doesn’t seek to invest in companies that are closely aligned with the movement of stock markets. Let us work through the logic behind our approach here:

Cashflow is king
We believe a portfolio of quoted small and micro-cap companies generating large cash surpluses within their business can deliver attractive longer-term returns in the coming years. Abnormal cash surpluses often occur after a business reaches the end of a long period of investment, or sometimes when a niche market trend becomes more mainstream.

Whilst the share prices of businesses generating surplus cash may not rally as quickly as companies that move closely in line with stock markets, in general they have greater potential for positive returns in our view which means they could succeed even when equity markets themselves are flatlining.

If their share prices stay low, they can choose to use their new cashflow to buy back shares. Others might pay a dividend, bringing in new buyers for their company’s shares. Alternatively, companies generating abundant surplus cash can use it to accelerate their growth, by scaling up investment in their operational teams or product range. Others can use surplus cash to buy businesses that offer a major synergy.

Finally, a company generating a stream of good and growing cashflow is attractive to third-party businesses, which may lead to takeover offers at good valuations.

Strength in numbers
A portfolio investing via a list of concentrated holdings may work for more mainstream small and medium sized company strategies, investing as an example 2% of a portfolio in each holding. The problem comes with when considering micro-caps, as by their nature, they may not be large enough to reach an arbitrary 2% portfolio weighting. So, a small-cap portfolio with a short list of holdings has the problem that it may have to exclude all quoted micro-caps, irrespective of the strength of their investment case.

Hence, institutions typically only become interested in investing in micro-cap companies after their share prices have risen strongly and their market capitalisations and equity valuations have risen dramatically. At this point arguably they have become small caps.

In our experience, quoted micro-caps appear to have the advantage of low market valuations, and yet still carry bags of upside potential. Effectively, quoted micro-caps are sometimes literally too small or too cheap for institutional investors to buy in sufficient size.

We certainly don’t have these restrictions, and as a result the Trust portfolio carries the potential for future positive returns from overlooked micro-caps.

Micro-cap be nimble, Micro-cap be quick.

Thirdly, micro-caps don’t just mimic larger companies in smaller form. Typically, they are less mature, and as such often operate in new and innovative industry sectors that haven’t become large enough for the mainstream companies. Furthermore, being small they often have scope to be nimbler and to look to take opportunities more quickly than their larger counterparts.

During global recessions, smaller companies often have commercial advantages over large caps. Whilst these periods are challenging for all companies, sometimes demand in less mature industry sectors persists, so they can continue to thrive during global recessions.

Furthermore, whilst the mainstream stocks can and do acquire businesses from a receiver at knock down prices, in general these transactions only add marginally to their prospects. In contrast, the same transaction for a quoted small-cap company typically delivers much larger potential positive returns. In the case of micro-caps, sometimes these deals can be transformational to their prospects.

For all these reasons, the returns on a small and micro-cap portfolio are not necessarily closely aligned to the fluctuations of the mainstream stock market. The investment universe is so wide-ranging that it is possible to diversify company specific risk more effectively across such a portfolio, when compared with larger, mainstream stocks.

What are the Trust’s prospects given the current investment climate?

As a direct answer to this question, we are more upbeat than we have been for the last three decades for the following reasons.

First, we believe we are on the threshold of a radical change in investor preferences, away from pro-globalisation strategies, which we expect will favour the UK stock market.

Second, we believe that a portfolio investing in companies that are set to generate significant cash surpluses will have the advantage of minimising company specific risks, which we believe may be very elevated given current high inflation.

Third, we believe that as many businesses become at risk of becoming insolvent, the greatest upside potential may lie with quoted micro-caps, currently standing on what we consider cheap share prices.

Fourth, if markets flatline in future, we believe that strategies that have the potential to deliver positive returns in such market conditions become a lot more important.

The bottom line is that we feel the prospects for the Miton UK MicroCap Trust are not just strong. Specifically, we believe its prospects are strong at a time when many of the mainstream global stock market indices have become less attractive due to the challenges of inflation.

If this analysis is correct, then we expect that institutional allocations to UK smaller companies will steadily increase over the coming years, driving up their valuations, reducing their cost of capital and making it easier for them to fund capital expenditure and acquisitions that may further enhance their growth prospects.

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Risks

Investing involves risk. The value of an investment can go down as well as up which means that you could get back less than you originally invested when you come to sell your investment. The value of your investment might not keep up with any rise in the cost of living.

Higher inflation can lead to some investments falling in value, particularly those with a fixed level of interest, for example government bonds and corporate bonds. The value of an investment might not keep up with any rise in the cost of living.

Investment in smaller companies is typically higher risk than investment in larger companies. Shares in smaller companies can experience greater levels of volatility.

The share price of companies (equities) can experience high levels of price fluctuation.

Forecasts are not reliable indicators of future returns.

Glossary

Active management: An approach to investing whereby a fund manager invests according to their judgement. The active investor aims to beat the returns from an asset class, such as company shares or bonds, or specified benchmark index/sector, rather than to match them.

Assets: Different groups of investments such as company shares, bonds, commodities or property.

Beta: The measure of the volatility of a security or portfolio compared to the market, which it is a part of.

Bond yield: This is calculated by taking the level of interest paid by the bond, divided by the price of the bond, expressed as a percentage. As the price rises, the yield falls and vice versa.

Capital: Describes financial assets, particularly cash, or other assets, such as shares, owned by a person or organisation.

Equities: Another name for shares (or stock) in a company.

Inflation: The rate of inflation is the change in prices for goods and services over time.

Micro-cap: A micro-cap is a stock with a market value of between £50 million and £300 million. Micro-cap stocks tend to have greater volatility, thus are inherently riskier, than larger-cap stocks.

Mid-cap: Mid cap stands for middle capitalisation and is a term used to group stocks and shares. Sitting between large- and small-cap stocks, mid-cap stocks have a valuation of between £350 and £2.5 billion

Large-cap: Sitting above mid-cap and small-cap stocks, large-cap stocks generally have a valuation, or market capitalisation, of more than £2.5 billion.

Quantitative easing (QE): A monetary policy whereby a central bank purchases predetermined amounts of government bonds or other financial assets in order to inject money into the economy to expand economic activity. It has the opposite effect to quantitative tightening.

IMPORTANT INFORMATION:

Whilst every effort has been made to ensure the accuracy of the information provided, we regret that we cannot accept responsibility for any omissions or errors.

Any views and opinions expressed here are those of the author at the time of writing and can change; they may not represent the views of Premier Miton and should not be taken as statements of fact, nor should they be relied upon for making investment decisions.

Investing involves risk. The value of an investment can go down as well as up which means that you could get back less than you originally invested when you come to sell your investment. The value of your investment might not keep up with any rise in the cost of living.

Premier Miton is unable to provide investment, tax or financial planning advice. We recommend that you discuss any investment decisions with a financial adviser.

Reference to any stock, fund or investment should not be considered advice or an investment recommendation.
All data is sourced to Premier Miton unless otherwise stated.

A free, English language copy of the trust’s full Prospectus, the Key Information Document and Pre-investment Disclosure Document are available on the Premier Miton website, or copies can be requested by calling 0333 456 4560 or emailing [email protected]

Financial Promotion issued by Premier Portfolio Managers Limited, (registered in England no. 01235867), authorised and regulated by the Financial Conduct Authority, a member of the Premier Miton Investors marketing group and a subsidiary of Premier Miton Group plc (registered in England no. 06306664). Registered office: Eastgate Court, High Street, Guildford, Surrey GU1 3DE.

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By clicking accept you acknowledge that your use of this website is subject to our privacy policy, cookie policy and our general legal and compliance information available on our website.

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The content of the pages of this website is for your general information and use only. It, and the products and services described within it, are subject to change without notice. We shall not be liable to you, or any third party, for any amendment, modification, suspension or discontinuance of any product or service described on our website. Neither we, nor any third parties, provide any warranty or guarantee as to the accuracy, timeliness, performance, completeness or appropriateness of the information and materials made available on this website.

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THE UNITED STATES OF AMERICA:The investment products referred to on this website have not been and will not be registered under the United States Securities Act of 1933, as amended. They may not be offered or sold in the United States of America, its territories and possessions, any State of the United States of America or the District of Columbia or offered, sold or transferred to US Persons (as defined below). The investment products referred to on this website have not been and will not be registered under the United States Investment Company Act of 1940, as amended. Premier Portfolio Managers Limited has not been and will not be registered under the United States Investment Advisers Act of 1940.

“US Person” generally includes the following: (a) any natural person resident in the United States; (b) a partnership or corporation organised or incorporated under the laws of the United States; (c) any estate of which any executor, or administrator, is a US Person; (d) any trust of which any trustee is a US Person; (e) any agency or branch of a non-US entity located in the United States; (f) any non-discretionary account or similar account (other than an estate or trust) for the benefit or account of a US Person; (g) any discretionary account or similar account (other than an estate or trust) held by a dealer or other fiduciary organised, incorporated or (if an individual) resident in the United States; and (h) any partnership or corporation if: i. organised or incorporated under the laws of any non-US jurisdiction; ii. formed by a US Person principally for the purpose of investing in securities not registered under the 1933 Act. In addition, a Shareholder must qualify as a “Non-United States Person” as used in the US Commodity Futures Trading Commission (“CFTC”) Rule 4.7.

Investment products referred to on this website may not be sold or transferred to a US citizen, or an entity taxed as such or required to file a tax return as such under the United States federal income tax laws (a “US Tax Resident”).

The information in this site is solely for the purpose of acquiring information as, or for, an Institutional Investor (a corporate or other non-retail investment professional acting for their own account). This information must not be used or relied upon by anyone that may be considered a “retail investor” by the home regulator of the country from which this site is accessed.  

The information contained in this website is directed at persons who are resident in the United Kingdom and complies with appropriate UK legislation and regulations and is not directed at, nor intended for distribution to, or use by, persons in any jurisdiction in which the dissemination of such investment related information is not permitted.

The information or opinions contained herein should not be construed as an offer, or solicitation to deal in any investment or fund nor shall any such investment products or services be offered or sold to any person in any jurisdiction in which such offer, solicitation, purchase or sale would be unlawful or in which the person making the offer solicitation is not qualified to do so or to anyone to whom it is unlawful to make such offer or solicitation.

Premier Miton Investors has expressed its own views and opinions on this website, and these may change and there is no obligation to update them. Nothing in this website should be construed as investment, tax, legal or other advice. The information contained herein is subject to change without notice.

Neither Premier Miton Investors nor any of its group companies or affiliates accepts any liability for any losses arising directly or indirectly from any information accessed from this website, to the fullest extent permitted by law.

By clicking accept you acknowledge that your use of this website is subject to our privacy policy, cookie policy and our general legal and compliance information available on our website.

THE UNITED STATES OF AMERICA: The investment products referred to on this website have not been and will not be registered under the United States Securities Act of 1933, as amended. They may not be offered or sold in the United States of America, its territories and possessions, any State of the United States of America or the District of Columbia or offered, sold or transferred to US Persons (as defined below). The investment products referred to on this website have not been and will not be registered under the United States Investment Company Act of 1940, as amended. Premier Portfolio Managers Limited has not been and will not be registered under the United States Investment Advisers Act of 1940.

 “US Person” generally includes the following: (a) any natural person resident in the United States; (b) a partnership or corporation organised or incorporated under the laws of the United States; (c) any estate of which any executor, or administrator, is a US Person; (d) any trust of which any trustee is a US Person; (e) any agency or branch of a non-US entity located in the United States; (f) any non-discretionary account or similar account (other than an estate or trust) for the benefit or account of a US Person; (g) any discretionary account or similar account (other than an estate or trust) held by a dealer or other fiduciary organised, incorporated or (if an individual) resident in the United States; and (h) any partnership or corporation if: i. organised or incorporated under the laws of any non-US jurisdiction; ii. formed by a US Person principally for the purpose of investing in securities not registered under the 1933 Act. In addition, a Shareholder must qualify as a “Non-United States Person” as used in the US Commodity Futures Trading Commission (“CFTC”) Rule 4.7.

 Investment products referred to on this website may not be sold or transferred to a US citizen, or an entity taxed as such or required to file a tax return as such under the United States federal income tax laws (a “US Tax Resident”). If those investment products are held by a US Person, a US Tax Resident or a person who does not qualify as a “Non-United States Person” within the meaning of CFTC Rule 4.7, Premier Portfolio Managers Limited shall be entitled to redeem such Shareholder’s entire holdings.