Realise the big potential in micro-cap stocks with this investment trust

The Downing Strategic Micro-Cap Trust had a disappointing start. But it's finally looking like it's ready to achieve its potential.

Cake makers making cake © Getty Images

It's been a wretched two and a half years since the Downing Strategic Micro-Cap Trust (LSE: DSM) raised £54m to invest in struggling companies that needed active management input to sort them out. The net asset value has fallen by 27%, the share price by 34% and one investment has been completely written off.

The team led by Judith MacKenzie had such a good record with their Growth Fund following the same approach that targeting an annualised return of 15% (over three to seven years) for Downing seemed reasonable. So the micro-cap trust's lousy start has been disappointing.

Subscribe to MoneyWeek

Become a smarter, better informed investor with MoneyWeek.

The best explanation comes from Nick Greenwood, manager of Miton Global Opportunities Trust. "The Downing style," he says, "throws up two or three opportunities a year and requires a lot of heavy lifting, including sitting on boards of directors and changing management." Finding 12-18 opportunities in the year they set themselves to become fully invested was demanding and led to some rushed investments.

Gaining hands-on experience

The result is a "J curve" in terms of return on investment: major downside to share prices during the period of disruption to the business before the actions are rewarded with a rising share price. This has required more patience than expected, but the team has also learned to be more ruthless with firms. "We've tended to back firms with owner-managers and high levels of insider share ownership, but [their] boards don't like to be challenged."

Advertisement - Article continues below

The portfolio is now 88% invested in 12 firms. "The justification for investing was that we had a management team to sort the business out and we thought we could exit despite working-capital problems," says MacKenzie. No new investments are expected; the cash is available for the opportunistic topping up of holdings or to participate in further fund-raisings.

A tasty main holding

Turning Real Good Food around has been problematic; MacKenzie only found out about serious corporate governance issues after she joined the board. Still, steady progress has been made in rationalising its five divisions and cutting excessive costs. Similar progress in the other investments should result in significant capital appreciation. The team thinks the portfolio valuation can rise by 60%.

This has prompted an investment worth 7% of DSM from Greenwood. He also thinks "micro-caps have suffered a perfect storm as they are perceived to be domestic and exposed to Brexit. Fund managers are consolidating and far fewer than before can now buy the smallest firms. Finally, post-Woodford there is a witch hunt against firms with poor liquidity." So the valuation of smaller companies, especially very small ones, is depressed while the outlook for DSM's investments has at last turned up. Yet Downing estimates that they trade on just 6.2 times their earnings per share. DSM's shares, meanwhile, trade on a 9% discount to net asset value. They finally look ready to achieve their potential.




Why investment trusts are the best vehicle for your money

Max King explains the advantages of investment trusts – sometimes called closed-ended funds – over their open-ended counterparts (or Oeics).
11 Feb 2020

Investment trusts: the Cinderella of investment arrives at the ball

Investors should look beyond the market noise of a single year and examine the bigger picture. Max King explains what we can learn from 25 years of in…
8 Jan 2020
Stock markets

Seven investment trusts to make your investments go global

The outlook for equities remains encouraging. An investment trust with an international remit will help you profit.
23 Jul 2019
Share tips

Give these 19 investment trusts a chance

Investors should spare a thought for these 19 out-of-favour investment trusts, says David Stevenson.
2 Jul 2019

Most Popular

Stocks and shares

Do you own shares in Sirius Minerals? Here’s what you need to do now

Mining giant Anglo American has proposed a cash takeover of Yorkshire-based minnow Sirius Minerals. Unhappy shareholders must decide whether to accept…
20 Feb 2020

The euro’s slide against the US dollar looks set to continue

The euro has been in a bear market against the US dollar for two years now. And on a broader scale since 2008. A decline like that is telling us somet…
19 Feb 2020
UK Economy

Britain’s economy might spring a surprise on the doomsayers this year

The UK economy is looking pretty good – we’re more at risk of a boom than a bust, says John Stepek. Here’s why, and what it means for your portfolio.
20 Feb 2020

The rare earth metal that won't be a secret for long

SPONSORED CONTENT – You can’t keep a good thing hidden forever; now is the time to consider Pensana Rare Earths and the rare earth metals NdPr.
31 Jan 2020