Three small-cap stocks to shield you from the worst of the market's ups and downs

Each week, a professional investor tells us where he'd put his money. This week: Ken Wotton of Livingbridge Equity Funds selects three promising Aim-listed shares.

Managing risk is a crucial task for all investors. And with both economic and market volatility making a return in 2018, investors need stocks in their portfolio with the potential to protect them from the worst of the ups and downs.

We believe there are two significant ways to manage risk in micro caps and our favoured stocks reflect this view. First, we look for firms where the management team has a proven record of delivering on its promises. Secondly, we avoid businesses that are more exposed to cyclical shocks or uncertain consumer sentiment in favour of structural growth stories companies in markets or sectors where the conditions for sustainable growth are present.

The companies below meet those criteria. Even though they're all listed on Aim, the London Stock Exchange's board for smaller stocks, which investors often characterise as higher risk, we believe they are well protected against excess volatility.

Cashing in on the cloud

In the technology sector, the global giants and cutting-edge start-ups tend to make the headlines. But we think small and medium-sized technology companies with a proven business model and long-term cash-generative growth prospects can be just as exciting.

Nasstar (Aim: NASA) sells cloud-computing hosting services to small and medium-sized enterprises (SMEs). These SMEs understand the case for cloud versus on-premise IT, but don't have the capacity to develop their own solutions in-house, or the clout to get good value from the very large IT providers offering cloud services.

Nasstar, by contrast, offers a good option to the growing market of customers that want to develop cloud services. Cloud hosting, moreover, generates recurring revenues that give investors reassuring visibility of sales prospects.

Healthy returns from research

Ergomed (Aim: ERGO) is a contract research organisation (CRO) that works alongside pharmaceutical companies, which are increasingly keen to outsource their activities. Importantly, as a service provider to the pharmaceutical sector, CROs are protected from the risks inherent in drug development; their revenues do not depend on the drug's success.

Leading CROs such as Ergomed are nonetheless a vital part of the development process, helping businesses get their drugs and therapies to market by managing clinical trials and analysing patient data. Ergomed has a strong track record of acquiring clients and is seen as a market leader in several important sectors of the pharmaceutical industry.

Where there's fat, there's brass

Investors like well-run franchise businesses as they can scale quickly with no need for significant capital investment, but it's crucial that management can recruit franchisees who will deliver that growth.

Franchise business Filta Group (Aim: FLTA) has a track record of doing exactly that. Its franchisees use specialist equipment to clean the deep-fat fryers of restaurants and other commercial kitchens, which helps customers meet environmental and health-and-safety objectives while also prolonging the life of their kitchen equipment. In a short space of time, Filta's franchisees have built up a 5,000-strong customer base who get a weekly service.