The micro-cap space can be a fertile hunting ground for those scouting high-return hidden gems. But while smaller companies offer the potential to grow faster than larger firms, they are also riskier propositions.
Co-managed by Victoria Stevens since its launch in 2016, the five-star rated Liontrust UK Micro Cap fund has been a great source of alpha for investors, producing annualised returns of 18.4% over the past three years - some 7.7 percentage points ahead of its Morningstar category.
The fund invests only in UK-based businesses with a market capitalisation of less than £150 million. To earn a place in the portfolio, stocks must have at least one “intangible asset” such as intellectual property, strength in distribution or recurring income.
“We invest only in companies that can make a good profit," says Stevens. “We shy away from unproven businesses that haven’t made any money yet.”
Buy: Totally PLC (TLY)
Stevens bought Totally shares at 10p, and already they are trading at around 14p. The company provides out-of-hospital care to UK patients and has two divisions: one outsources emergency care and the other offers medical services and procedures to reduce long waiting lists in hospitals.
She likes it because the company gets long-term contracts (at least three years) which provide a recurring revenue stream, meaning the firm's earnings are relatively predictable. Steven adds: “The service the business provides improves the efficiency of the NHS, which is struggling with the ongoing problem of growing demand, particularly for emergency care."
Still a nascent business, Totally has a £25 million market cap - to put that into context, the average market cap on the FTSE All-Share is £3.14 billion. But Stevens expects the business to grow to at least ten times that size, and plans to hold it until that happens: “Assuming everything goes well and there aren't any profit warnings," she adds.
Hold: James Cropper (CRPR)
Stevens classes herself as a “buy and hold” investor, who doesn't like to trade in and out of stocks, even though the micro-cap space can be volatile, which can create trading opportunities. “We like to hold companies for the long term and let the businesses do the work for us by growing,” she says. “ It allows us to be more relaxed about timing, not to worry about when to enter or exit from a position.”
James Cropper has been in the fund since March 2017, and she has topped up the holding along the way. She says: “It’s an interesting business located in the Lake District. They have been producing paper for over 200 years.”
The company has three divisions; the main one makes the low-volume high-quality coloured paper that it’s used in Burberry carrier bags, while the most profitable one is Technical Fiber Products, which provides the aerospace industry with a material made up of carbon fibres called non-woven. “You can find it on the outside of aircrafts made by Boeing and Airbus, and Ferrari and Lamborghini use it in their cars," says Stevens.
The third division is 3D Print, which produces environmentally-friendly paper packaging that substitutes more polluting plastic packaging. Stevens, however, points out that it’s very difficult to make it and keep the colour: “You have some pulp and you crush it under high pressure into shape. But when you crush it, the colour gets lost.” It is the growth of this final division over the next decade that Stevens is particularly excited about and which will ensure she stays invested for the long-term.
Sell: Tracsis (TRCS)
Stevens recently sold the fund's take in technology company Tracsis because of a change in its ownership. When the firm's chief executive, John McArthur, stepped down from the business the proportion of the company owned by management fell below 3%. Stevens likes company management to have so-called skin in the game i.e. to own a decent amount of their own business, as it means they are motivated to run the company with the long-term in mind and their interests are aligned with shareholders'.
Tracsis provides software solutions to problems across the transport sector. Steven first bought the stock when the fund launched in March 2016 and the share price has since climbed 25%, as well as providing a further return through dividends. Over the same period the market cap of the company has roughly doubled. “There was nothing fundamentally wrong with the company, this is just a hard rule we have,” she explains. “It’s a good software company in the transportation sector.”
