Though there has been some quite sharp volatility due to macroeconomic headwinds such as eurozone woes and a plummeting oil price, the past six months has been a good time to have been invested in large-caps.
The FTSE 100 is now up more than 6 per cent over that time, having surpassed its record high and even breached the psychological barrier of 7,000 in recent weeks.
However, one of the major reasons for those gains has been a prolonged period of “risk-off” sentiment within the investor community as due to issues such as the upcoming UK election, worryingly low levels of inflation and marginalised economic growth, market participants have favoured the perceived safety of mega-caps.
As a result companies with a smaller market capitalisation have generally struggled, with data from the Investment Association showing that smaller companies funds have seen net outflows in each of the last nine months – and as the graph below shows, it has been FTSE AIM-listed stocks which have been the worst hit by this negativity.
Performance of indices over 1yr
Source: FE Analytics
However, Gervais Williams – who heads up the Miton Income, CF Miton UK Multi Cap Income and CF Miton UK Smaller Companies funds – says this poor relative performance means that micro-caps have never looked better value.
“The FTSE 100 index, excluding banks and commodities, is now on a P/E ratio of 17.7 times and even if you look at the FTSE 250 it is on 16.2 times,” Williams (pictured) said. “However, the AIM is now much cheaper at around 8 or 10 times.”
“The disparity in valuations between micro-caps and large-caps is now extremely steep. I can’t remember a time when they have looked so cheap relative to large-caps.”
Williams also points out that this underperformance has been going on for some time now as while the FTSE All Share has gained 48.23 per cent over five years, the FTSE AIM index is up just 6.52 per cent over that time.
Given the low valuations on offer but the opportunity for significant growth over the longer term, Williams says he couldn’t be happier to launch his new Miton UK Micro Cap Trust over the coming months.
While he understands there are short-term risks on the horizon, Williams thinks that as investors can find much higher levels of capital and dividend growth in the micro-cap arena, the coming decades could be a phenomenal time to be invested in small and innovative companies.
“Certainly, the valuations we have been gifted now we are going to be launching this trust are fantastic,” he said.
“Yes, we all know that there will be volatility with the general election and that will present a number of pluses and minuses. However, over the longer term these things sort themselves out.”
While he is very happy with the cheap share prices on offer, Williams is keen to stress that there isn’t just a valuation argument to buying sub-£150m companies today.
He points out that, in spite of super-low interest rates, large budget deficits and sizeable QE injections of liquidity into markets, world growth has slowed significantly recently and many larger companies are now struggling to find attractive areas for capex.
He says both of these factors make it harder to generate organic revenue growth and this is limiting profit, cashflow and dividend growth and that the sizeable falls in commodity prices suggest this growth hangover will be with us for an extended period.
Performance of index since Sep 2000
Source: FE Analytics
“Following QE investors are finding it difficult to find areas where returns could be substantial. We believe UK micro-caps may have strong recovery potential,” Williams said.
While it is commonly viewed that smaller companies offer better long-term growth than large-caps, Williams says their potential has been kept under lock and key over the past 25 years or so as the globalisation of financial markets meant investors could find plentiful growth in blue-chip stocks while small-caps have been seen as “fiddly and illiquid”.
Performance of indices since Jan 1988
Source: FE Analytics
As a result of the present low growth environment, Williams says that is now changing and the future market is likely to be similar to one presented to investors between the mid-1950s and late-1980s.
Data from the Numis Smaller Companies Index Q3 Review in 2012 shows that between 1955 and 1988, micro-caps delivered twice the return of general smaller companies and 14 times more than the wider UK equity market.
“That goes back to a time when you had some pretty dysfunctional governments, a major oil crisis and currency crises, etc. All that would suggest that you would have wanted to buy large companies or look overseas, but despite all that uncertainty a lot of smaller companies delivered huge amounts of growth.”
The reason for that outperformance, according to the manager, was prior to the credit boom, the rate of UK economic growth was volatile – in part due to inflationary and currency crises. However, he says the key advantage of smallness is their extra growth potential which is particularly important at times of weak economic trends.
Investors could be forgiven for thinking that Williams is simply plugging his asset class with his new investment trust soon floating.
However, while he runs a number of small-cap orientated portfolios, he also was made co-manager on the Miton (formerly Psigma) Income fund last year which is far more large-cap orientated. Since he joined Eric Moore, he has increased the fund’s weighting to small and micro-caps given his thoughts on the current market.
There are also a number of other industry experts who agree with Williams’ views.
In a recent FE Trustnet article, Hargreaves Lansdown’s Mark Dampier said a huge buying opportunity had opened up at the bottom end of the FTSE All Share given the huge outflows from open-ended funds and the considerable widening of discounts in the investment trust sector.
“They’re unloved, unwanted and unfashionable at the moment. When they bounce back I don’t know, but historically they’ve come back 30 or 40 per cent very quickly. It’s proven a good accumulation opportunity in the past,” Dampier (pictured) said.
Williams has been investing in UK equities since the early 1990s and has comfortably beaten his peer group composite over the longer term.
Performance of manager versus peer group composite since Jan 1990
Source: FE Analytics
According to FE Analytics, both his CF Miton UK Smaller Companies and UK Multi Cap Income funds are both top decile performers in their respective IA sectors since launch.
His new trust will purely invest in companies with a market-cap below £150m at entry and is expected to float at the end of the month. Its management charge is expected to be 1 per cent and as it is targeting stocks which should grow their income, it will pay a quarterly dividend.