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AA-rated star warns on small-cap bubble

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AA-rated star warns on small-cap bubble

Small caps are entering bubble territory, according to Judith MacKenzie, manager of the soon-to-launch Downing Strategic Micro Cap investment trust.

Citywire AA-rated MacKenzie (pictured) is concerned that UK smaller companies with a market cap of £300 million to £400 million are starting to look highly valued. But she believes the companies she is targeting, below £150 million in size, are less ‘aggressively priced’.

‘If I went further up the market cap scale, I would not feel comfortable as things have gotten more expensive. Many companies with a £300 million to £400 million market cap look expensive. A lot has been driven by “IHT-money” [from inheritance tax portfolios] coming into the market. These “darlings” are bought regularly,’ MacKenzie explained.

‘I think there is a bit of a bubble within that space, which is why I want to focus on an area of the market that is not as aggressively priced.’

Downing is looking to raise £100 million for the Strategic Micro Cap trust, which will hold between 12 and 18 investments in some of Britain’s smallest listed companies. MacKenzie and co-managers Alyx Wood, James Lynch and Nicholas Hawthorn believe they can generate an average compound annual total return of 15% over three to seven years.

The trust will be run along similar lines to the open-ended MI Downing UK Micro-Cap Growth fund, launched in 2011, which has built a successful track record. Over five years to the end of February, the fund returned 133.6%, compared with 89.5% by the average fund in the UK Smaller Companies sector.

Downing UK Micro-Cap Growth is currently £28 million in size and will be ‘soft-closed’ to new investors when it reaches £30 million. The new UK Micro-Cap trust will therefore provide another option for investors who are looking to access the team’s approach.

MacKenzie (pictured) and her team seek to unlock value by proactively engaging with micro caps that are undergoing change, for example by restructuring boards and aligning management incentives with shareholders.

The manager favours companies with a market cap of sub-£50 million, as they are generally under-researched by analysts and other investors.

The team has been working on a pipeline of potential businesses over the past 18 months. As they seek out companies that are undergoing corporate change, MacKenzie predicts it could take 10 to 12 months before the portfolio is fully invested – and by this she means around the 85% mark. She declined to disclose any of the potential holdings of the new trust.

‘There will be some crossover [with the open-ended fund]. My guestimate would be to expect that once we are fully invested there could be five to six positions that are similar,’ she added.

IT security specialist Accumuli is a prime example of the team’s approach in action. They invested in 2011, helping the business to select a chair and chief executive. Over a four- to five-year period they engaged with the management team on the growth strategy and held the stock until it was sold to NCC for around £55 million in 2016. The investment generated a return of 417% for Downing.

Other live investments include engineering services company Redhall and Pennant International Group, which manufactures military training simulators.

MacKenzie believes the trust’s annual management fee of 1% of net assets is justified given that the team comprises five dedicated investment professionals who will focus on up to 18 companies. No performance fee will be levied.

‘You are not going to get that intensity of fund manager ratio to funds under management within any other [rival] business,’ she added. 

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