FE Alpha Manager Harry Nimmo voiced concerns in an interview with FE Trustnet last week, claiming that the large volumes of money pouring into funds such as CF Miton Multi Cap Income and Marlborough Micro Cap Growth could result in a major sell-off if sentiment switches.
However, Williams (pictured) says that the micro cap market remains heavily under-invested in the grand schemes of things, making a liquidity crisis highly unlikely.“The key issue that I think Standard Life is raising is concern that institutional investment in micro-caps is a crowded trade, and that this could place investors at risk when several funds see redemption together,” he said.
“My view is that generally micro-caps are vastly under-owned by institutions when compared to other parts of the UK equity market.”
“Few general small-cap funds have significant holdings in micro-caps, and other UK OEICs tend to have none at all. The vast majority of micro-caps continue to be owned by a wide range of non-institutional investors, with the management teams and their families often being some of the largest investors.”
Even if Nimmo’s concerns did turn out to be justified, Williams says that the Multi Cap Income fund and Diverse Income trust are still relatively small, with assets of £397m and £294m, respectively.
Some of the largest funds in the IMA UK Smaller Companies fund are more than £1bn in size, including Nimmo’s Standard Life fund.
This, as well as the fact that the funds invest in other types of company aside from micro caps, means that liquidity risk is less severe, Williams says.
“The new Multi Cap Income funds are still very immature in terms of scale.
They have attracted significant inflows but even so overall the funds are still relatively small compared to other groups of institutional funds,” he said.
“Even so it is worth considering how risky these funds might be for investors were there to be some sizable redemptions in the sector.”
“The first point is that these funds are multi-cap so around one third or more of these funds are invested in the most liquid stocks. They are not just holding micro-caps.”
He says that the defensive nature of the companies he invests in makes the risk even smaller.
“Being income funds most of the micro-cap stocks we hold are income-generating. If there was a sizable set back in the markets then stocks like these would have increasing yields. Income stocks tend to have rather lower volatility than other quoted stocks for this reason,” Williams explained.
“Micro-cap stocks often have better balance sheets than their larger quoted comparatives too. Certainly it is interesting that on a look through basis the Miton Multi Cap Income fund has net cash balances, though this analysis doesn’t include leases.”
Williams further cuts down on liquidity risk by holding a vast number of companies.
No single company in CF Miton Multi Cap Income has more than a 1.7 per cent weighting, and the top-10 positions account for just 14.7 per cent of assets under management.
Fellow micro-cap manager Giles Hargreave, who runs the Marlborough UK Micro Cap Growth and Nano Cap Growth funds, runs a similarly diversified portfolio.
Miton Multi Cap Income currently has a sizeable PUT option on the FTSE 100, which would further help the fund offset liquidity risks in the fund.
The strong performance of micro-caps has helped the Miton fund to top the IMA UK Equity Income sector since its launch in October 2011, with returns of 82.96 per cent.
As well as being number one in the total return stakes, the fund has one of the lowest annualised volatility scores in the sector over the period, even though it invests at the low end of the market cap scale.
This goes to show how seriously Williams considers when running his portfolio.
Performance of funds and sector since Oct 2011
Source: FE Analytics
By comparison, Nimmo’s own Standard Life UK Smaller Companies fund has had a torrid time of late, which has seen it fall to the bottom quartile of its IMA UK Smaller Companies sector over one and three year periods, and year-to-date.
The correction in the mid-cap market hit Nimmo (pictured) particularly hard.
Though his fund sits in the small cap sector, he takes the Numis Smaller Companies index as his benchmark, which includes the bottom half of the FTSE 250.The manager is known for “running his winners”, which means that he sometimes has up to 20 per cent of companies with a higher market cap than those in his benchmark.
The vast majority of Standard Life UK Smaller Companies’ top-10 holdings are small caps, including Rightmove and Supergroup, which are both down more than 15 per cent in 2014.
Williams say that contrary to Nimmo’s comments, it’s his favoured area that is most at risk from a sizeable correction.
“If anything it is interesting to note that the UK part of the market that does appear to be a crowded trade is around the middle sized quoted companies,” he said.
“Most mid and large cap OEICs have some underweight positions in the largest stocks like Shell. This is offset by an overweight in the mid-caps which have massively outperformed in the last 15 years.”
“Equally most small-cap funds also have an overweight position in mid-caps that offsets their underweight position in the micro-caps. So if anything there is a general institutional overweight position in mid-caps.”
“Interestingly it is this area of the market that is currently causing some concern as it has started underperforming. Most mid and large cap OEICs have underperformed recently because the largest stocks have done well.”
Performance of indices in 2014
Source: FE Analytics
FE data shows that the FTSE 250 has been on a downward trend since March, and is just about breaking even for the year.
Micro-caps, measured by the FTSE Fledgling index, have continued to perform well, up almost 10 per cent in 2014.
If UK equity fund managers continue to take profits in mid-caps and move into cheaper FTSE 100 companies, Williams says this could cause a problem for those who have a natural bias to the FTSE 250.
He points out that on a price-to-earnings basis micro-caps are also cheaper than mid-caps.
“Most smaller company funds are underperforming [this year] because micro-caps have outperformed,” the manager said.
“This is leading to some investors to redeem those funds heavily overweight in the midcaps and buy into fund like Micro Cap Income.”
“Also some fund managers of smaller company funds are looking to reduce midcaps to buy the less expensive micro-caps. All this has been reflected in the notable underperformance of midcaps.”
“Overall we are comfortable that clients are not taking great risk in our Multicap Income fund,” Williams finished.
CF Miton Multi Cap Income has closed to new money, but investors can still get access to Williams via the Diverse Income trust and CF Miton UK Smaller Companies fund.
