Fund Managers' Favourites: More Small-Cap Picks

Video Transcript:
Alanna Petroff: As investors, we all know about large-cap opportunities. But we often don’t hear about the small-cap opportunities out there simply because we don’t hear about small-cap companies very often. That’s going to change. I’m joined today by Mark Niznik. He manages the Artemis UK Smaller Companies Fund, which is a Gold-Rated fund. Specifically, here is what the analysts have to say:

'A major attraction of this fund is the expertise of manager Mark Niznik. He began his career in 1985 and the majority of his experience has been focused on small-cap companies. Moreover, the investment process is robust as Niznik’s philosophy is to focus on high-quality companies that demonstrate resilient business models. The investment approach is based upon growth, value, estimate revision, and momentum.'

So Mark, let’s discuss your top picks right now.

Mark Niznik: Okay. Thanks. My top picks at the moment, one of them would be Brooks MacDonald. One of my first jobs when I came into the City was discretionary private client fund management. What I learned from that is that the client money is very, very sticky and that’s what Brooks MacDonald does. They basically look after about GBP 3.5 billion of private client money. These are quite long-term assets: they are in SIPPs, in self-invested pension plans. The average age of their customer base is in the mid 40s. This is investing for the long-term. They charge about a 1% management fee for investing that pot of cash and that assets under management since Brooks started in 1991 has grown on average 30% a year.

Petroff: Not bad.

Niznik: Which is an incredible achievement. I don’t think they can grow at that rate going forward, but I think 20% is achievable and that profit drops straight down to cash. P/E of 20, it's one of the best businesses that I’ve come across. So, that’s my first pick.

The other one that I particularly like at the moment is H&T, which is a pawnbroking business. It's the largest pawnbroker in the UK. What attracts me about this business is basically it is providing short-term secured loans against jewelry, typically a ring. So, if I was hard up and I couldn’t get the money elsewhere, I might take my ring to a pawnbroker. They would weigh it and give me a value based on the smelt value of that gold and they would charge me 8% a month interest; so very, very high monthly interest rate with no risk because it’s a secured against the value of that gold. What I particularly like about this business is that in 75% of the cases, the customer (i.e., me) comes back and redeems that.

Petroff: 75%.

Niznik: Yeah, exactly. So it’s a very, very high recurring earnings. H&T have grown that pledge book, or the total of their loans, by double-digits: about 13% per annum for the last couple of decades. Yet, historically, the shares are on a P/E of about six times earnings. So that’s a very, very high-quality recurring earnings stream when interest rates are so low, at 8% a month interest. That’s very valuable into the future, to my mind.

Petroff: So now there is another company: our last company that we wanted to go over was R.E.A. Holdings, and that is a very different company than anything I’ve heard of recently.

Niznik: Yeah, the three are very different actually. R.E.A. is the old Rubber Estate Agency and what this is--it's a UK-headquartered company--but their business is in palm oil. This is in Indonesia: in East Kalimantan in Indonesia. One of the things I like about this is the supply/demand story. There is very limited supply of land for new palm oil. So, it can only growth near the equator in areas of very high rainfall.

The demand for palm oil is increasing because of the industrialisation of emerging markets. As people get richer they start basically frying more food rather than boiling it. So, the per capita consumption of palm grows. R.E.A has been planting palm consistently over last decade or so. One of the things I like about this is that it takes three years to get your first crop that you can actually harvest and then from year three to year seven, your harvest expands exponentially. And then from years 7 to year 25, you just get an annuity revenue stream of cash flows. All you have to do is let the rain fall and bit a of fertilizer is your maintenance capex on that annuity stream. So, it's a very high-quality recurring earnings once you’ve built out your land.

Petroff: They have the land all set to go now, because they've been planting for years.

Niznik: Absolutely. They haven't, like some competitors in Indonesia, had a hiatus with planting during the 2008-09 recession. They continued planting. So, they're not guaranteed, but you would expect them to grow their crop, their production, double-digits per annum for the next several years. Yet they're only on a P/E of eight times earnings. So, to my mind, that's a mispriced company.

Petroff: There are always risks with any investment that we would go into. What do you think the main risks are for each of these three investments?

Niznik: Right. I think with Brooks MacDonald the main risk would be the funds under management are predominantly equity invested. So, stock markets go up and down. Although they rise long-term, if markets fell, that would be a risk. Their assets under management and, therefore their profits, would be hampered. So, that's one for Brooks.

For H&T, if the gold price was to fall substantially, that would undermine the security to that loan I was talking about. So, that would be maybe a potential issue with them.

Similarly, again, commodity price with R.E.A., if the palm oil price fell substantially that would be a negative for R.E.A.

Petroff: Okay. Well, thank you for joining me today.

Niznik: Sure. Thanks.

Petroff: That was Mark Niznik from Artemis and I am Alanna Petroff. Thanks for joining us on Morningstar.