Miton UK MicroCap 16 February 2024

The Miton UK MicroCap Trust (MINI) provides investors with access to the ‘unjustifiably low valuations’ and option-like upside of companies in the UK small- and micro-cap equity markets. Gervais Williams and Martin Turner have managed MINI since its launch in 2015, employing a bottom-up focused approach to identifying surplus cash-generating micro-cap businesses, trading at valuations below their perceived intrinsic valuation. The current 74% allocation to the AIM market provides diversification versus the typical UK equity portfolio, alongside a greater exposure to companies with exponential growth potential. For example, MINI’s largest holding, Yu Group, has delivered a 400% return since the start of 2022. That said, the portfolio is diversified across sectors and holdings to help minimise the impact of drawdowns and overall risk. MINI is not geared.

Tighter macroeconomic conditions and the unloved status of the UK equity market has made it challenging for MINI to generate consistent performance. However, Gervais and Martin believe the current moment is the best opportunity in 30 years and have been adding to their highest conviction positions. For example, CyanConnode was increased following a fall from 25p to 10p during a recent capital raise and came with a free 18-month warrant with an exercise price at 15p, multiplying its returns potential. Gervais and Martin also expect the compounding characteristics of UK equities to entice international investors looking for alternative investment opportunities as the era of globalisation subsides and growth proves harder to come by. They expect this to filter down to high-quality, surplus cash-generating smaller companies, leading to a return to the long-term trend of small-cap outperformance.

MINI offers an annual redemption facility. In November 2023, 18.7% of shares were redeemed, reducing the trust’s assets, leading to a rise in the OCF to a capped level of 2%. Historically, the facility has helped reduce discount volatility. However, MINI’s discount had widened out to 10.5% at the time of writing.

In our view, MINI has been a victim of the tighter macroeconomic environment which has weighed heavily on investor sentiment towards microcaps. In addition, idiosyncratic factors have impacted the share price performance of some of its largest positions rather than a breakdown in the managers’ investment case. These include a delay in orders at CyanConnode and the Israel–Hamas conflict impacting MTI Wireless (see Performance section). We think that sentiment may be turning towards the UK small-cap market, and we remain optimistic that Gervais and Martin’s research process can uncover those companies that have strong fundamentals and surplus cash.

We believe MINI can provide a viable diversification opportunity away from more mainstream, internationally focused large-cap equity strategies, and with large caps having performed well in 2023, small caps could be due a catch-up. Should interest rate cuts come during the year, and inflows into UK equities pick up, the current discount may also provide a good long-term opportunity for shareholders. In our view, the best opportunity may not remain for very long if investor sentiment starts to shift, especially given the option-like recovery potential displayed by smaller companies in the past. That said, the significant redemption of shares over the past two years does mean high costs need to be borne at present.