Tiny companies can deliver epic returns – here’s how to invest in them

Small caps ain't as small as they used to be. The mainstream definition of a small cap stock is now any company valued below £1bn.

That's left a space for a new breed of stock the nano cap.'

I admit this new term is mildly annoying, but it does serve a useful purpose. It covers the real small fry: companies with a market value of £100m or less.

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It's often the case that the smallest companies deliver the biggest returns for investors, so I think any private investor should at least consider investing in nano caps.'

What's more, it needn't be that difficult as a new nano cap fund was launched last month. And it's managed by one of the UK's top investors.

A new fund investing in tiny companies

Marlborough Nano Cap Growth Fund

The UK Micro Cap Fund invests in companies with market values below £250m. It has delivered a total return of 180% over the last five years. That's well ahead of the benchmark index, which rose by 107% over the same period.

Unsurprisingly, the new nano-cap fund has already received a lot of money from investors - funds under management have already reached £90m. This popularity has been a mixed blessing for Hargreave. That's because it's easier to run a successful smaller company fund if the fund itself isn't too large.

Why's that? Well, let's imagine you're running a smaller company fund with £500m to invest.

You spot an undervalued business with a current market cap of £30m. You buy 10% of the company. Your purchases push the share price higher, so you end up paying £3.5m for a 10% stake. The company's value then doubles, so your stake is worth £7m and you've made a £3.5m profit.

Now that profit is all well and good it's always nice to double your money! But if your fund size is £500m, a £3.5m profit isn't going to make much difference to your fund's overall performance.

Because Hargreave doesn't want to manage a fund that is too big, the UK Nano Cap Growth Fund has already been soft closed', less than a month after the fund was launched.

In other words, now that it has £90m under management, the fund is effectively trying to put off new investors. This has been done by raising the initial charge to a chunky 5.25%.

Now, when all is said and done, I still wouldn't rule out investing in the Marlborough UK Nano Cap Growth fund, even with this initial charge. I have a lot of faith in Hargreave's abilities and I think there's a good chance he will deliver a very strong performance over the next decade.

Another nano-cap fund to consider

One option is a tiny fund called the SF Webb Capital Smaller Companies Growth Fund. Unlike the Marlborough Nano Cap fund, it's not explicitly focused on sub-£100m companies, but if you look at the fund's ten largest investments, they're all currently valued at less than £50m.

What's more, the fund has only £4.6m in funds under management. That means it can take full advantage if the manager spots a cheap company with a market cap of, say, only £20m.

And the manager has a pretty decent record. His name is Peter Webb, and he was very much a star small-cap fund manager back in the nineties and early noughties. In fairness, his record isn't perfect, and he stepped back from the City in the late noughties for a few years.

But Webb is now back. And given his record in the 90s, I think he deserves the benefit of the doubt. You don't often get the opportunity to invest in a fund managed by someone of his pedigree where the fund size is so small.

It's also worth noting that you can currently invest in this fund without paying an initial charge. This special offer lasts until December 31st. After that the charge will be 3%, which is reasonably low for an actively managed fund. It's clear that Webb doesn't want to drive away investors.

Hunting for promising small companies yourself can be very enjoyable

My most recent investment in this end of the market is a company called Mirada (LSE: MIRA), which develops set-top box technology for digital TV. The company is profitable and has several significant broadcast customers in Latin America. It's one of Peter Webb's current favourites.

Now I've only invested a small amount of money in this company because I know that like most nano-cap plays, it's pretty risky. But I'm happy to own the shares as part of a wider portfolio.

If you want more small cap investment ideas, there are plenty more in our Red Hot Penny Shares newsletter. It's written by my colleague, former fund manager David Thornton you can learn more about the big investment idea that's got him most excited right now here.

And just before I go here's something that may well interest you, particularly if you weren't able to make it to the World MoneyShow last week. You can register free to explore MoneyWeek's online booth at the eMoneyShow on14November, and watch live webcasts from the World MoneyShow London. Trading and investment experts, including our very own editor-in-chief Merryn Somerset Webb, veteran trader John Burford, and wealth manager Tim Price, will be sharing their views. If you can't make it during the eShow, you can still catch any of the webcasts On-Demand until 5 December: register free today.

Red Hot Penny Shares is a regulated product issued by Fleet Street Publications Ltd. Your capital is at risk when you invest in shares; never risk more than you can afford to lose. Past performance is not a reliable indicator of future results. Please seek independent financial advice if necessary. Customer Services: 020 7633 3600.

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