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FE Alpha Manager Wotton: Small cap picture improving despite macro uncertainties

26 April 2017

Ken Wotton, manager of the Wood Street Microcap Investment fund, outlines why strong issuance numbers in 2016 prove the small cap market is as buoyant as ever.

By Jonathan Jones,

Reporter, FE Trustnet

Small caps remain attractive thanks to relatively high issuance numbers increasing liquidity and investors remaining cautious due to outside macroeconomic factors, according to FE Alpha Manager Ken Wotton.


Last year, smaller companies lagged their blue-chip peers as the large-cap FTSE 100 index outperformed the Numis Smaller Companies ex IT index by 7.99 percentage points.

This underperformance was partly due to the Brexit vote in June, which caused investors to flee to ‘safer’ investments at the top end of the market spectrum now known as the ‘expensive defensives’. It was further compounded by the global equities rally following Donald Trump's election victory.

Despite the disappointing year, over the longer term small-caps have outperformed and over five years the Numis index – which includes a number of mid-cap companies –  is ahead of the FTSE 100 by 47.14 percentage points.

Performance of indices over 5yrs

 

Source: FE Analytics

The manager of the five crown-rated Wood Street Microcap Investment said: “Even though the last several years have been a pretty strong bull run for small caps, when you look at the numbers it hasn’t really felt like that as there has always been quite a bit of volatility and uncertainty.”

He says this is because each year since the financial crisis there have been ‘aftershocks’ felt in the market.

“Literally every year since then there has been some major geopolitical or macroeconomic uncertainty which has potentially clouded sentiment,” he said.

“The new normal is almost to expect the unexpected and there is going to be something that will shake sentiment at some point in the short-term.


“If I look at this year, I don’t know what it’s going to be. But it’s a safe planning assumption that there will be major shifts in sentiment probably due to something unexpected and therefore you have to be ready and positioned to take advantage of that if it happens.”

While this is unsettling in the short term for investors, longer-term this should create good entry points for investors willing to buy-and-hold, he said.

Part of this is holding enough in cash to be able to take advantage of pricing anomalies if there are any when these shocks occur.

As such, the manager has 7 per cent in cash – which is slightly above the long-term average but not by much – and has a mandate to hold at least 5 per cent (with a maximum of 10 per cent).

However, one positive sign for investors at the lower end of the spectrum in 2016 was the surprisingly robust issuance numbers seen throughout the year.

“One of the many unusual things about last year was that – despite the volatility in the market and despite the fact that there was pretty major uncertainties which potentially affected the economic backdrop for the companies – actually the fundraising environment in small-cap was quite buoyant,” Wotton said.

“If you look at the UK equity issuance and IPO stats overall you would see that last year was down materially year-on-year and 2015 was down on 2014 as well but actually in the micro-cap arena it was reasonably buoyant throughout the year.”

This helps fund managers on two fronts as it shows that despite the noise, companies remain active in their respective industries and also gives improved liquidity to those looking to alleviate some of the issues surrounding investing at the lower end of the market spectrum.

“The big picture didn’t seem to be stopping company management teams from being active and trying to move their businesses forward,” he explained.

“Possibly because the uncertainties are so big and the time duration they are going to last for is so uncertain as well they just can’t afford to sit there and do nothing.

“So unlike other periods of uncertainty where companies have just sat on their hands and not done anything that has not been the case at all this time.

“And that is quite encouraging not only for the outlook of the economy but also from an investment point of view because there is a steady stream of new opportunities to invest in.

He added: “We’re not exclusively deal driven but an important element of what we do is look at company fundraising as a liquidity point to get into stocks.

“We’re investing in an area of the market that is obviously less liquid than larger companies so finding a way to get in and out of stocks is a core part of the skill of what we do when investing in this part of the market.”

For domestic investors, this should also translate to the UK economy with many smaller companies more domestically-focused and therefore a decent barometer for the health of the domestic focus.


“I feel I am in a privileged position of being a barometer for the health of the UK smaller business and therefore the economy and people are ‘cautiously optimistic’,” Wotton said.

“Looking forward to this year, obviously people are worried about Brexit and what the ramifications of that will be and the fact that we’ve had the currency movement means inflation is definitely coming and people are looking at how to react to that.”

However, he says this could translate to opportunities for smaller companies as naturally increasing prices should help to improve balance sheets.

Wotton runs the £68.5m, which has outperformed the IA UK Smaller Companies since its launch in 2009, is a top quartile performer over the last five years.

Performance of fund vs sector and benchmark over 5yrs

 

Source: FE Analytics

Over the last half-decade the fund has outperformed the sector by 55.47 percentage points and has made a positive return in every calendar year since its launch in 2009.

“The outlook for 2017 remains uncertain with the potential for macro and geopolitical events to impact sentiment. However, the fund continues to focus on areas of secular growth and companies that have the potential to grow profits even without a tailwind from the wider economy,” Wotton said.

“Market volatility combined with ongoing small company capital raising activity should present attractive investment opportunities for the fund.”

The fund has a clean ongoing charges figure (OCF) of 1.02 per cent.

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