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
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.