Smaller companies and specifically the Alternative Investment Market (AIM) have changed drastically over the last two decades but investors do not fully appreciate that, according to Octopus Investments’ Richard Power.
The manager of the £36m FP Octopus UK Micro Cap Growth fund said that nowadays world-leading companies are being spawned very quickly with many coming through the small-cap spectrum – yet few investors have dedicated exposure to this.
Perhaps this is down to the poor performance of the AIM index, which has largely done nothing over the last decade, up 18.73 per cent, as the below chart shows.
Performance of indices over 10yrs
Source: FE Analytics
However, Power said the market does not work especially well as an index and should therefore not be treated as a benchmark by investors.
Within the market, he added, there has been a big step-change in the last 10 years which has not necessarily been reflected at an index level.
He argues that too many people see the index as just a place for domestic, smaller companies to raise capital, without recognising that it is an area populated by up-and-coming internationally focused companies.
Power said: “Certainly when I joined the City and started investing in smaller companies you had a collection of engineering businesses and small service businesses that did very well during the upturn when there were lots of crumbs off the big boys’ tables and got hit very hard in periods of economic turmoil.
“Now you have got truly global success stories with predominantly overseas earnings and you have very different market dynamics with global-leading businesses being created and established within two or three years. That was impossible 20 years ago.”
He added: “I think the whole small-cap landscape has changed so much that people really need to go back and revisit how much of their portfolios should be exposed to proper genuine growth business as these are global leaders a lot of them.”
One example of the changing nature of the market was the Brexit vote in 2016, when despite a lot of negative sentiment and rhetoric towards smaller companies, AIM stocks held up remarkably well.
“Our first concern was that all these companies that we were excited about the prospects for the next three-to-five years are going to be vulnerable to overseas takeovers,” Power said.
“We generally don’t like these companies being taken over as we invest in them because we see the growth potential way beyond what a buyer may pay for here and now.”
As it happens, however, none of this took place and Power admitted he found it “surprising” quite how little impact the referendum result had on businesses and their chief executives.
Yet he said it is another example of how international the market now is, as the once domestic index was relatively untroubled by the large fall in sterling.
Performance of sterling vs dollar over 3yrs
Source: FE Analytics
“People forget how international AIM is. Behind the FTSE 100, AIM has the highest proportion of overseas earnings of any of the other UK indices – so more than the FTSE Small Cap and FTSE 250 as well,” Power said.
“Across out portfolio about 55 per cent is overseas earnings. So no, they didn’t miss a step [during Brexit].
“You always get negative stock market sentiment and we always remind ourselves that it is nothing more than a voting machine at the end of the day; you get sellers and buyers and share prices go down.”
“We can’t ever have any influence over sentiment. We will continue to back companies that we think have good growth prospects. “
As long as nothing has fundamentally changed within a business’s long-term growth potential, dips can often lead to buying opportunities, he added.
“We go into companies thinking we want to be long-term co-owners of these businesses – we are not trading in and out of companies because we think they look cheap or expensive over the short term. It is offering investment opportunities for us as long-term managers,” he said.
And while investor sentiment appears to be quite volatile, the market seems to be on sure footing with a healthy stream of new opportunities, suggesting that businesses have not been put off in the same way as investors.
“If you look at the IPO and secondary fundraising activity, 2017 was a much stronger year than 2014,15 or 16. I think over £2bn has been raised over the first four months of 2018 so run-rate of over the £6bn that was achieved last year as well. That level of activity reflects the confidence,” Power said.
Power is the lead manager of the FP Octopus UK Micro Cap Growth fund, with deputies Dominic Weller and Chris McVey joining him in 2016.
Since its launch in 2007 the fund has returned 145.78 per cent, beating its Numis Smaller Companies plus AIM ex IT index by 54.89 percentage points while 41 basis points behind the IA UK Smaller Companies average.
Performance of fund vs sector and benchmark since launch
Source: FE Analytics
The portfolio, which has a strong growth bias, is 23.39 per cent weighted to support services stocks with 12.08 per cent in media companies and 11.25 per invested in software and computer services firms.
FP Octopus UK Micro Cap Growth has a clean ongoing charges figure (OCF) of 1.67 per cent.