UK Edition
It hasn’t been an easy time for investors in Britain’s smallest listed companies. These “micro-cap” stocks were already shunned by investors before the pandemic over Brexit uncertainty and liquidity concerns following the Woodford collapse. Things went from bad to worse when Covid-19 came along and knocked many micro-cap shares for six.
This has resulted in a bumpy ride for a number of micro-cap investment trusts, not least Downing Strategic Micro-Cap, which we tipped in July 2019.
At the time we advised holding the trust alongside River & Mercantile UK Micro Cap and Henderson Opportunities (which holds firms of all sizes but has a bias towards Aim stocks) in order to tap into opportunities in this unloved part of the market. Earlier this month we also tipped Gresham House Strategic, which targets cash-generative micro-caps at distressed valuations.
The good news is that our micro-cap trusts have recovered ground since the dark days of March. For example, R&M UK Micro Cap’s share price has risen by 108pc, while Henderson Opportunities is 92pc higher. Downing Strategic Micro-Cap’s shares have risen by a respectable 65pc.
- Sign up to our Business Briefing newsletter for a snapshot of the day's biggest business stories
- Read Questor’s rules of investment before you follow our tips
Even before the pandemic, Downing Strategic Micro-Cap had suffered a number of setbacks among its investments; one, Redhall, a specialist engineering group, went into administration in June 2019.
As the manager, Judith MacKenzie, runs a concentrated portfolio of around 12 stocks, there is nowhere to hide if something goes wrong. She adopts a “private equity style” approach, working alongside company managers to unlock value for shareholders.
The virus outbreak exposed weaknesses in three other holdings: Pennant International, a training provider, and two transport firms, Braemar Shipping and Gama Aviation. Ms MacKenzie responded by reducing the trust’s position in Pennant and selling the other two.
This formed part of a broader exercise in which each of the trust’s positions was assessed to see if the balance sheet and management team were strong enough to survive the pandemic. In a recent update Ms MacKenzie said all her remaining investments had the “crucial survivability factor”.
What are the trust’s prospects now?
It’s important to mention that trading has been suspended in the “open-ended” Downing UK Micro-Cap Growth fund, also managed by Ms MacKenzie. This decision was taken earlier this month by the fund’s “authorised corporate director”, Maitland, after assets fell to £8.4m – a level deemed unviable.
Maitland and Downing are evaluating options, including rolling the portfolio into another fund. However, if a solution isn’t found the fund’s holdings will be liquidated, which is not ideal in a part of the market that is less liquid.
Fortunately, the “open ended” fund is not a replica of the investment trust. The overlap equates to only 5pc of the trust’s net asset value, which is largely in cable manufacturer Volex (a successful Questor pick). A spokesman for Downing pointed out that this stock offered good liquidity.
As a result, any asset sales from the fund should not drag down the prices of the trust’s holdings; the fund’s suspension has not so far had an impact on the latter’s share price.
In spite of the challenges that Downing Strategic Micro-Cap has faced, Questor believes it has turned a corner. Its NAV has gained 35pc since the March sell-off and its discount has narrowed from 28pc at the end of September to 17pc today. Downing said the recent positive vaccine announcements would “kickstart” a number of markets that its companies operate in.
Launched in 2017, the portfolio is currently in the third year of what Ms MacKenzie describes as a five to seven-year cycle – and in some cases Covid may have extended this. However, positions such as Hargreaves Services and Synectics are currently trading at a 50pc discount to book value. Patience will be key. Our advice is to hold.
Questor says: hold
Ticker: DSM
Share price at close: 59.5p
Read the latest Questor column on telegraph.co.uk every Sunday, Tuesday, Wednesday, Thursday and Friday from 6am.