Miton UK MicroCap Trust (MINI) was launched in 2015 and invests predominantly in a portfolio of smaller UK companies, typically with a market capitalisation below £150 million.
The managers, Gervais Williams and Martin Turner, argue that the growth potential of smaller companies is less dependent on general economic conditions than larger companies’; their view being that smaller companies often have strong growth potential regardless of whether they operate in a market that is contracting overall. This advantage, they say, potentially unrecognised by some investors, has resulted in the micro-cap sector considerably outperforming the FTSE All-Share Index. Since 1955, when the data was first collected, the FTSE AIM index has outperformed the FTSE All-Share Index by an average of 5% per annum.
Gervais and Martin aim to add alpha within the micro-cap universe, by looking for overlooked stocks with a disproportionate upside if they succeed. This strategy means that there is a diverse portfolio of companies operating in different niches. The approach has a relatively high turnover, with gains continually being reinvested in other potential ‘winners to come’.
Since the trust was established MINI’s most significant outperformance, relative to peers, has occurred in the last year, boosted by a variety of single stock successes: including in the healthcare, technology and climate change arenas. The trust has been the strongest performing one in the AIC UK Smaller Companies sector over the past six months and year, also dramatically outperforming the open-ended sector. This outperformance has not been translated to recognition by the market, however, and the trust trades at around a 13% discount.
We see MINI as an excellent vehicle for investors who are looking to increase their exposure to an uncertain UK recovery, which has potential pitfalls along the way. Due to the size of the companies in the portfolio, and the secular growth stories that many take part in it, the performance of the trust shouldn’t be so reliant on the wider economy; the companies should be be in a better position whether we see a fast and strong rebound or not. In addition we note that the discount has not responded yet to the much improved performance over the past twelve months and, with an annual tender offer provision protecting the discount to the downside, this juncture could prove to be an excellent entry point.
MINI is also a diversifier to the typical UK investors’ equity portfolio, with the AIM sector being significantly different in its composition compared with the FTSE 100 and FTSE 250 indices. There is a much greater exposure to the high growth areas of IT and healthcare, which are doing extremely well in the post-COVID environment – the FTSE All Share for example, has just 1.25% in technology. Furthermore there are considerably more quoted companies in the UK with a market cap less than £150m than above it, including a variety of idiosyncratic opportunities than can’t be found elsewhere. The wide variety of secular growth opportunities offers the potential for long-term returns with the right stock-picking.
|Turnaround in performance over the past year||High OCF|
|Attractive discount relative to peers, despite improved performance||Relatively illiquid underlying holdings|
|Offers diversification to mainstream UK equity funds||Relatively broad spread|
Miton MicroCap Trust (MINI) is a specialist vehicle which offers exposure to the AIM market, that accounts for around 2% of the overall quoted UK market. Gervais and Martin focus on companies that are valued below £150m, but they have invested in companies as small as £2m. In recognition of the high risks of investing in the smallest companies, the number of holdings in the portfolio is high at 110.
Gervais and Martin launched the trust in 2015, having identified there were tensions in the process of globalisation which could lead to long-term opportunities for micro caps. In their analysis, the effects of globalisation and the removal of barriers across borders have led to an era of low inflation and low rates. The reduced cost of imports – due to globalisation – have offset inflationary pressures, and interest rates in the developed world have therefore been kept lower. This development, along with easy access to credit, have led to misallocation of capital in global stock markets – in their view. In fact they say globalisation has concealed a wide range of issues, including the incredibly weak progress in productivity since the financial crisis. This situation has negatively impacted wage growth across the world and elevated political tensions, raising the question of the sustainability of the political and economic status quo. Gervais and Martin believed that it would lead to a backlash, which would favour more nationalist politics and smaller companies.
Following the launch of the trust, the thesis received support from the 2016 Brexit referendum and the election of Donald Trump later that year. However for the managers this support has not yet translated into the sustained tailwind for small caps that they anticipated. Over the last two years, in particular, the UK political logjam has held back the usual premium returns on micro caps. However the micro-cap tailwinds have showed renewed vigour in the final months of 2019 and in 2020 during the pandemic, as we discuss in the Performance section.
Typically the managers look for companies with a market capitalisation below £150 million. These holdings can be in companies as small as £2 million: which would normally be a liquidity issue for an open-ended fund, but is possible for an investment trust. Gervais notes that there are many more quoted companies in the UK with a market cap less than £150m than above it, and they typically sit in a range broader range of industries than the mainstream stock industries. This tendency means that, due to the size of the trust and the focus on low valuations (described below), when the company has success in an investment the upside can be unusually large. Examples can be seen in the Performance section.
Before making an investment decision, the team looks at five key areas:
Turnover growth - The team look for companies that increase their revenue regardless of economic conditions. They recognise that this as a key attribute for sustainable long-term growth. Typically these will be companies that are improving their current product lines, or innovating new ones.
Sustained margins - The managers look for companies that are trying to improve productivity in order to reduce the cost of goods, all while justifying an improved market price. They also look for companies that improve/sustain profit margins through offering exceptional customer service.
Management of risk - Typically the managers believe that those companies which generate attractive returns, aren’t always the ones that grow the fastest. Instead the managers look for companies that are growing at a more measured pace, and therefore do so with less downside risk.
Better balance sheets - The portfolio will usually be comprised of companies with net cash balances, or those with modest debt. The managers have observed that companies which are under-geared are often able to remain profitable during times of economic setback.
Low entry valuations - The managers prefer stocks where the price reflects previous problems, rather than those where the price is based on future expectations.
The result is a well-diversified portfolio of around 110 companies, of which the top ten make up 32% of the portfolio (31/08/2020). Turnover can be reasonably high, as Gervais and Martin’s approach is to recycle profits into more attractive opportunities when their calls come good and outsized returns have been achieved.
top ten holdings
||% of nav
|Frontier IP Group
|SIMEC Atlantis Energy
|Caledonia Mining Corporation
|Corero Network Security
|Jubilee Metals Group
|MTI Wireless Edge
|Venture Life Group
Source: Miton UK MicroCap as at 31/08/2020
Another attractive feature of the trust is that it offers diversification not only to the peer group, having one of the lowest correlations to the Numis Smaller Companies Index in the UK Smaller Companies sector, but also in terms of industry diversification compared to the FTSE 100.
sector exposure compared to ftse 100
Alongside the equities in the portfolio, the trust has previously also held a put option on the FTSE 100. This approach has been extremely beneficial for the trust, as we discuss in the Performance section, which sold the option near the bottom of the market in March 2020. The managers tell us that, although they may consider purchasing another protective out in the future, it is unlikely that another will be purchased in the near future; given the cost drag of rolling the position and the fact they think they bought the option at a particularly attractive entry point.
The managers have the ability to gear up to 15% of the NAV. Although they do not anticipate gearing becoming a permanent feature of the trust, it will be used opportunistically in the future. Nonetheless they are yet to use this facility since launch and, as at the end of August 2020. the trust had net cash of c. 7% of NAV.
Launched in 2015, Miton UK MicroCap was designed to to profit from a reaction against the era of globalisation. Initially the performance of the trust was strong. However Q4 of 2018 saw a setback in UK small caps, as ongoing political deadlock and Brexit uncertainties led many asset allocators to steer clear of the UK. MINI has gone back to its winning ways, however, and the trust has been the standout performer in the UK Smaller Companies sector in recent times.
Over the past year the trust has NAV total returns of 34.1%, eclipsing the IA and AIC smaller companies sectors – which have returned 4.3% and 1.3% respectively. This outcome is the strongest return of any trust in the sector and has been achieved at a standard deviation of 33.8%. The managers believe that this result illustrates the long-term potential in the micro-cap space, and the benefits of micro-cap companies in uncertain environments. The unique blend of companies which sits within the universe, in particular, has been supportive of returns: as has been demonstrated by the broad mix of companies contributing the strongest returns to the portfolio over the past year. The top two contributors, Synairgen and Avacta, both sit in the med-tech space, and are therefore benefitting from their previous research and its potential uses to fight COVID-19. However the third best contributor, SIMEC Atlantis, is finding ways to deliver energy via low carbon installations. While the fourth best contributor, Jubilee Metals, reprocesses metals out of tailings from old mines. Collectively this combination means that the performance isn’t reliant on the growth or good fortunes of a specific industry or sector.
Alongside the strong performance from the underlying companies in the portfolio, the trust’s FTSE 100 Put option also aided the strong performance. The option was sold in March of 2020 for £2.7m, generating a profit of £1.8m on an original purchase price of just under £1m. This money was then used to fund additional investments, at a time when many valuations were standing at unusually low metrics.
Over the longer term the performance has also been strong, despite difficult market conditions. After launching in 2015 the trust has had a number of headwinds, namely surrounding the political uncertainty and the impact of Brexit. The final quarter of 2018 particularly impacted the trust, weighing down returns which would otherwise have outperformed the benchmark and peers. Over five years the trust has had NAV total returns of 25.5%, which is marginally behind the AIC peer group return of 30.1%. The IA sector has a return of 41.0%. The standard deviation during this period has remained low at 14.1%, as has the downside capture ratio of close to 0.45.
Initially the dividends for the trust were particularly strong, with two of the portfolio holdings yielding over 10% at the time of purchase. After two years these companies were taken over, and since then the dividend income from the portfolio has been at a lower level.
However, due to the type of companies that the managers look to invest in, dividends are not a priority and MINI yields just 0.2%. Nonetheless the managers holdings that go on to start paying dividends are often sold, and this means that the managers often refer to the trust as an early stage income fund.
In FY20 a full year dividend of 0.10p was declared. This figure compares to a dividend of 0.20p the prior year.
Gervais Williams and Martin Turner run the portfolio. They both have decades of experience in the UK small-cap sector. Gervais joined Miton in March 2011 and is senior executive director of the company. After starting as a portfolio manager in 1985, the majority of his career has been spent as head of UK smaller companies at Gartmore. Martin Turner also joined Miton in 2011 and has had a long-term working relationship with Gervais. Martin has widespread experience in the investment world as head of small/mid-cap equities, at companies including Rothschild, Merrill Lynch and Collins Stewart.
Both Gervais and Martin are part of a tight-knit team of six UK-focused managers at Miton: an asset management firm that has genuinely active management at the core of their business. The company runs multi-asset and equity funds, as well as investment trusts. Collectively they manage close to £9.1bn, as at March 2020. Last year it was announced that Miton would be merging with Premier Asset Management in an all-share merger deal, which saw shareholders receive around 0.3 shares in Premier for each Miton share – valuing them at around 56.7p, a 38% premium. The combined business has helped them to offer a greater range of products at a greater scale, along with benefitting from economies of scale and a diversified revenue mix.
As we discuss in the Performance section, returns have dramatically improved in 2020. However the discount has remained wide relative to historical and peer group averages.
Currently the trust is trading at a discount of 13.8%, in comparison to a peer group weighted average of 11.0%. The one year average discount for the trust is 10.0%. As can be seen in the five year graph below, the trust’s discount has been persistent over the past couple of years, principally due to the uncertainty surrounding Brexit and its impact on microcaps. With greater reliance on the UK economy, smaller companies are often seen as more vulnerable than the bigger more global stocks. However this trend may not always be the case, as shown during the COVID-19 period. Gervais and Martin believe that small-cap stocks’ flexibility and access to external capital puts them in a better position to thrive, regardless of the economic conditions.
The trust does have a discount control mechanism, allowing investors an annual tender. The most recent tender, in June 2020, resulted in investors redeeming nearly 20% of the trust.
An important feature of the trust is that the management fee is based on share price, rather than asset value. This feature aligns the managers interest with investors, in that it incentivises them to see the share price trade at NAV rather than on a discount. The relatively small size of the trust, with a number of fixed costs, does mean that the OCF of 1.68% (as of the most recent factsheet in August) is higher than the sector average of 0.82%. However in September the management fee was reduced from 1% to 0.9%, and this move should reduce the OCF going forward.
The KID RIY for the trust sits at 1.63% in comparison to a sector wide average of 1.39%. It is worth noting, however, that calculation methodologies can vary.
Environmental Social and Governance (ESG) factors are considered throughout the process at Miton, alongside financial factors. A wide variety of sources of information regarding ESG are used, including company reporting, meetings with management and boards as well as external ESG research. However, given the team invest in micro-cap companies, the ESG policies and disclosures can be less robust. This tendency sometimes leads to lower ESG scores in holdings. Gervais notes, however, that this trend does not necessarily reflect higher ESG risk or poor ESG risk management, compared to larger companies in the same industry.
A particular area of ESG that the managers focus on is governance. They believe that an experienced chairperson and suitably composed board of directors is critical in a company’s long-term financial performance. In addition management expertise and appropriately aligned remuneration are important in implementing the company’s strategy and managing risks.
Last year saw Miton hire their first head of responsible investing, supporting their growth and expertise in the ESG area.