Micro-cap stocks: how to get huge returns from tiny firms

Micro-cap stocks are often overlooked, but the British market has plenty of them and their potential is massive. Max King picks the best two investment trusts in the sector.

“The smaller, the better,” says the London Business School, which has examined the performance of smaller companies since 1955. The compound annual return of the Numis Smaller Companies index, representing the bottom 10% of the UK market, has been 14.7% since then, 3.4% ahead of the All-Share index. The yearly return of the Numis 1000, representing the bottom 2%, has been 16.3%. 

Excluding investment companies, there are over 100 listed “micro-cap” companies with market values below £100m, but they only account for 0.2% of the total market by value. Another 50 have market values of £100m-£200m, adding 0.4% of total market value, but the inclusion of listings on Aim, the junior market of the London Stock Exchange, trebles the number of stocks.

Scouring this mass of tiddlers for bargains are two trusts, the River & Mercantile UK Micro Cap Investment Company (LSE: RMMC), launched in late 2014, and the Miton UK MicroCap Trust (LSE: MINI), launched a few months later. Both have assets of a little over £100m; target firms with a market value below £150m; and trade on discounts to net asset value (NAV) of around 3%. However, George Ensor, manager of RMMC, points out that his trust has also returned capital to investors four times, £57m in total, in order to limit its size. It has just 41 holdings and without that limit would have to increase that number or have larger and less liquid holdings. Gervaise Williams, MINI’s manager, is happy with 128 holdings.

The tortoise and the hare

It’s been a story of the tortoise and the hare. RMMC raced away under its first manager, who was then forced to leave owing to an obscure compliance issue. Its investment return has been 143% over five years and 44% over one. MINI has returned 94% over five years, but 92% over one. Both trusts struggled in 2018-2019, but MINI, with a strong bias towards value, struggled more. Having withstood the sell-off in early 2020 better than RMMC, it has since soared. This is probably due to Williams’s focus on “highly cash-generative stocks”.

Choosing between them is tough. Ensor is clearly finding his feet, but lacks Williams’s 30 years of experience. Inevitably, both trusts are full of stocks few people will ever have heard of. Ensor has moderated the growth focus of his predecessor: “growth is important, but we don’t want to overpay for it”. Williams notes that “it’s important not to get carried away by a good story”, though his exposure to information technology companies is, at 14%, ten percentage points higher than Ensor’s. By contrast, Ensor’s exposure  to the consumer and healthcare sectors is 32% compared with 17% for Williams.

Unparalleled choice in the UK

Williams sees particular opportunity in “the cyclicality of various financial and commodity micro caps, providing greater upside at a time of recovery from the pandemic. The potential could be even greater if [inflation takes off]. They have been out of favour for so long that it is easy to underestimate the full scale of their upside”. He has pushed exposure to these sectors up to about 40% of the portfolio compared with 32% for RMMC.

Neither trust has any borrowings and both have plenty of cash. As to the outlook, “what remains curious is how easy it is to find attractively valued companies capable of compounding value for shareholders over a multiyear horizon,” says Ensor. “The UK stockmarket is possibly unparalleled from this perspective.” Williams thinks that the low valuations of micro caps provide “better potential for recovery than other areas of the market” and thinks they could be “at the start of a brand-new supercycle”. This corner of the UK market is easily ignored, but promises rich returns for investors in either trust.

Recommended

How much should you save for retirement?
Pensions

How much should you save for retirement?

The majority of people under-save for retirement, but how much do you need for a comfortable life after work and what should you pay into your pot?
8 Dec 2022
The investment trusts and funds to buy for 2023
Funds

The investment trusts and funds to buy for 2023

With 2023 rapidly approaching, Rupert Hargreaves looks at some of the top investment trusts and funds to buy for the new year, with the help of AJ Bel…
8 Dec 2022
Air fryer vs microwave – which is cheaper to run?
Personal finance

Air fryer vs microwave – which is cheaper to run?

We compare the costs of an air fryer vs a microwave to see which one is more cost effective.
8 Dec 2022
Is it time to buy Gilts?
Government bonds

Is it time to buy Gilts?

Gilts offer a higher yield than most savings accounts and could be an attractive alternative for those with a large lump sum to invest.
8 Dec 2022

Most Popular

Is it cheaper to leave the heating on low all day?
Personal finance

Is it cheaper to leave the heating on low all day?

The weather is getting colder and energy bills are rising, but is it really cheaper to leave the heating on low all day or should you only turn it on …
1 Dec 2022
Radiator vs electric heater – which is cheaper?
Personal finance

Radiator vs electric heater – which is cheaper?

We compare the costs, pros and cons of radiators and electric heaters and see which one will help keep your energy bill as low as possible.
28 Nov 2022
The pros and cons of smart meters – should you switch?
Personal finance

The pros and cons of smart meters – should you switch?

A smart meter can help you keep tabs on your energy usage, but is it better than a regular meter? We take a look at smart meters vs regular meters.
2 Dec 2022