A recent Trustnet article highlighted the problems that can arise when a fund you own allows its assets under management to spiral upwards.
For example, a fund with £100m in assets could buy 10% of a £50m company, making it a 5% position in the portfolio. If this fund was £1bn in size, however, the position would be 0.5%, reducing its impact on the portfolio.
Even worse, if the £100m fund grew to £1bn, that original 10% position in the company would in theory grow to 50% if it wasn’t cut. Market takeover rules dictate that an investor must make a bid for a company if they own 30% or more of the shares.
Long before it reached this point, however, other issues related to liquidity would be likely to arise – investing large amounts of money into a tiny company will push up the share price, yet if the fund faces redemptions, it may struggle to sell the stock at the new elevated level.
This is especially important when investing in smaller companies. Small caps tend to deliver the highest returns if held for the long term, yet if you buy a successful fund in this area of the market, it is likely to balloon in size as it attracts more money from investors and its holdings grow.
With this in mind, Trustnet asks the experts for small-cap fund and trust picks that are less than £200m in size.
Liontrust UK Micro Cap
Ryan Hughes, head of active portfolios at AJ Bell, named Liontrust UK Micro Cap as his first pick.
He noted Liontrust has an experienced team that has built up an “exceptional” knowledge of the smaller companies universe over a number of years. It is headed up by Anthony Cross and Julian Fosh, who recruited co-managers Victoria Stevens and Matt Tonge in 2015, which Hughes said has “brought fresh thinking into the team”.
“With the team running a significant amount of assets across the broader UK franchise, it has been careful to manage flows into this fund with a high ongoing charges figure [OCF] to ensure only committed investors come in and this has kept assets down to below £200m,” he said.
“Those investors have been very well rewarded, though, with strong performance from a portfolio of predominantly AIM stocks, backed by a clear and consistent investment process.”
Liontrust UK Micro Cap has made 170.9% since launch in March 2016, compared with 107.5% from the IA UK Smaller Companies sector and 78.1% from the FTSE Small Cap ex ITs index.
Performance of fund vs sector and index since launch
Source: FE Analytics
The £171m fund has ongoing charges of 1.38%.
Unicorn UK Smaller Companies
Next up is Unicorn UK Smaller Companies. Hughes said that Unicorn has built up a strong understanding of investing in early-stage companies over the past 20 years, while developing relationships with successful management teams.
“Manager Simon Moon is well supported by the broader team and has been leading on the fund for eight years, but the fund has stayed small over that time at around the £50m to £100m mark,” Hughes continued.
“The fund is perhaps not quite as racy as some with more of a core focus, but that approach has worked well in the time that Moon has been running the fund.”
Data from FE Analytics shows Unicorn UK Smaller Companies has made 219.6% over the past 10 years, compared with 226.5% from the IA UK Smaller Companies sector and 146.4% from the Numis Smaller Companies Plus AIM (ex ITs) index.
Performance of fund vs sector and index over 10yrs
Source: FE Analytics
The £60m fund has ongoing charges of 0.87%.
River & Mercantile UK Micro Cap
Investment trusts don’t have liquidity problems to the same extent as open-ended funds, yet if they become too large, they will also find that it is not worth holding the smallest companies.
To prevent this type of issue arising in the River & Mercantile UK Micro Cap trust, it returns capital to shareholders once it rises to between £110m and £125m in size.
Dzmitry Lipski, head of funds research at interactive investor, described it as a “potentially promising UK smaller companies portfolio for the future”, although it is not on the group’s Super 60 list.
“The trust typically invests in firms with a free-float market capitalisation of less than £100m at the time of purchase – with a bias to businesses that can compound attractive levels of growth in profits and cash generation,” he said.
“George Ensor, who manages the portfolio, believes these companies have greater scope for growth and are often overlooked by larger funds and the investment-broking community.”
According to FE Analytics, River & Mercantile UK Micro Cap has made 193.1% since launch in December 2014, compared with gains of 134.8% from the IT UK Smaller Companies sector.
Performance of trust vs sector since launch
Source: FE Analytics
It is on a discount of 8.1%, compared with 13.2 and 14.7% from its one- and three-year averages.
The £101m trust has ongoing charges of 1.35%.
Odyssean Investment Trust
Lipski’s second trust-pick also failed to make interactive investor’s Super 60 list, yet the head of funds research still described it as “one to watch”.
“The investment trust, which has a net asset value of £138m, invests in quoted UK smaller companies, typically too small for inclusion in the FTSE 250,” he said.
“It is headed by Stuart Widdowson, who some investors may remember as a star manager of rival IT UK Smaller Companies investment trust Strategic Equity Capital, before leaving to set up his own firm.”
Widdowson and co-manager Ed Wielechowski come from a private equity background and try to use their experience from this industry to help push portfolio holdings to the next level.
Before investing in a business, they ensure they have identified something it could be doing better. After investing, they will engage with the management for one of three reasons: to help crystallise value, to stop companies making mistakes that destroy value, or to recover value if a company has taken a wrong turn.
The trust changed its investment policy in January to formalise screening and increase engagement with portfolio companies on environmental, social and governance (ESG) issues, due to the positive relationship between these themes and share price performance.
“The proposed amendments to the policy will represent a formalisation of this negative screening process, excluding companies with sales based on controversial weapons, civilian firearms and ammunition, gambling, sub-prime/predatory lending, oil & gas production, extraction and refining, inappropriate/unnecessary animal testing and alcohol and tobacco production (10% of NAV is allowed in alcohol/tobacco distribution and retail),” Lipski added.
“I think this is the first ESG fund in the UK small-cap space.”
Data from FE Analytics shows Odyssean Investment Trust has made 54.7% since launch in May 2018, compared with 40.5% from the IT UK Smaller Companies sector.
Performance of trust vs sector since launch
Source: FE Analytics
The trust is on a premium of 0.5%, compared with discounts of 4.1 and 1.9% from its one- and three-year averages.
It has ongoing charges of 1.35%, plus a performance fee.