It was ‘a great op­por­tu­nity’ last year. But does hold­ing mi­cro-caps make sense now?

They looked un­der­val­ued in 2019 and seem even more so now – we just need to wait for bar­gain-hunters to step for­ward

The Daily Telegraph - Business - - Business - RICHARD EVANS

NO GREATER op­por­tu­nity ex­isted among in­vest­ment trusts a year ago than the “mi­cro-cap” funds, Questor wrote then. Were we right?

If we go just by cur­rent share prices, our claim looks frag­ile. We tipped one new hold­ing in that col­umn in

July last year, Down­ing Strate­gic Mi­cro-Cap, and its shares have fallen by 24pc since then, while the two we rated as holds, River & Mer­can­tile UK Mi­cro Cap and Hen­der­son Op­por­tu­ni­ties, have lost 13pc and 12.6pc re­spec­tively. How­ever, no one saw Covid com­ing and the epi­demic has knocked many share prices for six. How did our three mi­cro-cap stocks fare be­fore the virus struck? Down­ing Strate­gic stood at 73p on Feb 21, just be­fore mar­kets be­gan to fall, so it had gained 16.8pc since our tip, while the other two had risen by 9.3pc

(Hen­der­son) and 0.6pc (River & Mer­can­tile). Per­haps we can claim that we were broadly on course up to that point.

Last year we said three things were hold­ing mi­cro-cap stocks and funds back: Brexit fears; the evap­o­ra­tion of fi­nan­cial ad­vis­ers’ in­ter­est in small trusts, as those that in­vest in the tini­est firms must in­evitably be; and wor­ries about liq­uid­ity in light of the Wood­ford col­lapse. These three fac­tors re­main and we can now add Covid-19 as a fourth.

The re­sult is that the mi­cro­cap trusts’ un­der­ly­ing hold­ings are cheap, of­ten trad­ing at about 10 times earn­ings, and the trusts’ dis­counts, which vary from about 25pc for Down­ing and R&M to 13.8pc for Hen­der­son, add fur­ther cheap­ness.

Of course, cheap things can stay cheap. But mean­while these trusts’ hold­ings are mak­ing prof­its and if the mar­ket over­looks their value there is every chance that ri­val firms will step in, al­though a re­vival of merg­ers and ac­qui­si­tions is more likely once the pan­demic is truly un­der con­trol.

We could there­fore call these firms a “slow burn” in­vest­ment at a time when only big growth stocks seem to hold any ap­peal for in­vestors. Sooner or later this will change, so we will hold on to the three funds.

Up­date: Aber­forth Smaller Cos/Split Level In­come

We wrote about these trusts three weeks ago in con­nec­tion with Questor’s (woe­fully un­der­per­form­ing) en­try in The Daily Tele­graph’s Fan­tasy Fund Man­ager com­pe­ti­tion. Both have re­cently an­nounced fi­nan­cial re­sults and told in­vestors what div­i­dends they pro­pose to pay.

The Split Level trust (so called be­cause it has zero-div­i­dend pref­er­ence shares in is­sue as well as or­di­nary ones) said in its re­sults for the year to June that it would have to cut its own divi be­cause of the cuts an­nounced by large num­bers of Lon­don-listed firms. How­ever, it will de­lay the cut un­til the cur­rent fi­nan­cial year by us­ing some of its re­serves and main­tain – or in fact very slightly in­crease – the pay­ment for the one that ended in June. The 4.22p an­nual div­i­dend equates to a yield of 8.5pc at the cur­rent share price. We don’t know by how much the fund will need to cut the divi for the cur­rent fi­nan­cial year so we can’t pub­lish a fore­cast or “for­ward” yield.

The Smaller Com­pa­nies trust an­nounced its in­terim re­sults. This longer-es­tab­lished fund has had time to build up big­ger re­serves, which en­abled it to raise its in­terim divi by 4pc to 10.4p and avoid any men­tion of pos­si­ble cuts ei­ther at the fi­nal stage or next year. If the fi­nal is in­creased by the same per­cent­age the an­nual div­i­dend will be 33.28p, which would equate to a yield of 3.9pc at the cur­rent share price.

The dif­fer­ent de­ci­sions these two trusts have made about div­i­dends il­lus­trate the im­por­tance of re­serves – some­thing we will see more ev­i­dence of in the com­ing months, this col­umn is sure. Both Aber­forth funds are holds.

In­vest­ment trust news

Wi­tan Pa­cific, an Asia-Pa­cific fund, is to change man­ager to Bail­lie Gif­ford and be­come fo­cused on China.

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