The manager of the £1.25bn Standard Life UK Smaller Companies fund says large inflows into the likes of CF Miton UK Multi Cap Income and Marlborough UK Micro Cap Growth has driven up the value of illiquid micro cap stocks. Should sentiment turn, he says investors could be left stuck in companies as share prices plummet. “The likes of Gervais Williams and Giles Hargreave have taken in an awful lot of money in the past few years and if you have a lot of money going into a sector and not that much to buy, it can push the sector up very quickly,” he said.
“I stress that Williams and Hargreaves are good managers but it is something that investors are forgetting about because everything appears to be going in the right direction.”
“In the long term micro caps is an area that can give you higher returns but it also carries a lot of risk because if the market is going down you are stuck with them.”
“The Numis Smaller Companies index in the past year [is up 19.8 per cent] whilst the FTSE Fledgling Index is up more than 30 per cent, which is a massive difference, and most of that growth has come in the past three months.”
FE data shows the FTSE All Share is up 12.74 per cent over the same period.
Performance of indices over 1yr
Source: FE Analytics
Historically micro caps have outperformed both small and large cap stocks but tend to fall much harder and faster in times of crisis, such as 2008. The FTSE Fledgling index has risen almost twice as much as the Numis Smaller Companies index and more than six times the rate of the FTSE All Share over the past 15 years, our data shows.
Performance of indices over 15yrs
Source: FE Analytics
Nimmo points out that both Williams (pictured) and Hargreave look to mitigate against liquidity risk by running highly diversified portfolios. Marlborough UK Micro Cap Growth currently has 255 holdings, for example, with the top-10 only accounting for 11.8 per cent of assets.
“I prefer having a more concentrated portfolio,” Nimmo said. The need to mitigate liquidity risk in these funds in particular has been made more acute by the surge of inflows into these funds of late, Nimmo says.
He adds that micro cap managers haven’t benefited from the recent surge in IPO activity.
“We have seen a crescendo of newly floated companies since March but many have been in the mid and small cap space – £200m-£2bn – but not in the micro cap area,” he said.
There are a number of funds that specialise in micro caps within the IMA UK Smaller Companies sector. Nimmo says a dozen of the 53 funds are in micro caps and “are all the top-performers at the moment.”
While small caps have suffered from a number of earnings downgrades and general profit-taking in 2014, micro caps have ridden the storm. FE Trustnet recently highlighted that Hargreave’s Micro Cap Growth fund and Williams’ Miton Smaller Companies fund were top-performers in the UK Smaller Companies sector year-to-date.
The £175m Miton and £406m Marlborough funds have been top quartile performers over the past year as well, with returns of 57.18 per cent and 36.23 per cent.
Performance of funds over 1yr
Source: FE Analytics
A miserable 2014, including a 50 per cent sell-off in one of his biggest positions, has sent Standard Life UK Smaller Companies to the bottom quartile of the sector over one year however.
Nimmo says that many of his holdings including ASOS have been hurt by hedge-fund shorting, which hasn’t impacted his rivals investing in micro caps.
“At the moment markets are heavily influenced by the activities of ETFs, derivatives, but particular by multi-asset, absolute return and global hedge funds who take views on top down trends. They might short growth stocks they see as early cyclicals,” he said. “With the rise of absolute return funds and passive funds there is far more top down volatility responding to perceived changes in the macro environment.”
“The best performing stocks at the moment are actually micro-cap stocks because the very smallest companies – the bottom 2 per cent of the market – are completely unaffected by the derivate like activity because there are no derivatives in microcaps.”
FE Trustnet will be speaking to both Williams and Hargreave (pictured) in the coming weeks to find out what they think of Nimmo’s comments regarding a potential liquidity crisis in small caps.
