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Amati’s Stevenson: The sure sign we’ve found a winning AIM stock

19 February 2020

The manager of the TB Amati UK Smaller Companies fund says running a VCT gives him an insight into micro caps before their growth “explodes”.

By Anthony Luzio,

Editor, Trustnet Magazine

It can often take a while for fund managers operating in the lower reaches of the market cap spectrum to work out if they have found a winning stock – less broker coverage and lower trading volumes mean that even if the underlying business is performing well, it can take some time for the share price to follow suit.

However, David Stevenson of the TB Amati UK Smaller Companies fund says his involvement in the Amati AIM VCT means his stockpicking skills often receive a vote of confidence ahead of the rest of the market.

While the manager’s open-ended fund tends to initiate positions in companies with a market cap of £100m to £200m, the closed-ended structure of his VCT means he is happy to invest in companies as small as £20m.

He said the VCT acts as a “nursery” for TB Amati UK Smaller Companies, with stocks eventually graduating into the open-ended fund when they reach a sufficient size – and it is at this point he often finds his stock selections are vindicated.

“There are very early-stage brokers that feed our pipeline of VCT deals, such as Panmure, Cenkos and Finncap,” he explained.

“But when a company gets to a certain level of maturity, it wants to widen the institutional awareness, so it will either move broker or go for a joint brokership, which takes it into the area of the main list – this will be brokers such as Peel Hunt, Numis, Liberum and Investec.

“And we know we are on to a winner when we get a call from that latter group of brokers who say, ‘we’ve just initiated this morning on a small-cap stock that you’ve never heard of’, when it is a stock we have already got in the portfolio.”

To illustrate why it is so important to get into these companies before they are pushed by the larger brokers, Stevenson pointed to a graph of the relationship between average rolling 12-month P/E (price-to-earnings) ratios and company size across the FTSE and AIM indices.

It shows that whereas the smallest stocks on the AIM have the cheapest valuations across the entire market, the largest stocks are the most expensive.

“Our job is simple,” Stevenson added. “If we’re investing at the £20m to £50m market cap and we spot tomorrow’s premium growth stories, then you’ve got that multiple spread to play as the companies become more profitable, pay dividends and get a wider institutional audience.

“Our job is to find those ahead of the rest of the market and that’s happened on half a dozen occasions. One of the reasons we performed so strongly in 2015 to 2017 was that a number of our VCT promotions exploded in terms of growth and we were in them ahead of the rest of the small cap universe.”

Stevenson, alongside analyst Gareth Blades and co-managers Paul Jourdan and Anna Macdonald, take an “unapologetically team-based” approach to running Amati’s investment products, voting on all decisions and eschewing the star manager culture.

He believes this collaborative technique is vital in the small cap market, as the full investable universe contains about 2000 stocks and you need “bandwidth” to uncover the maximum number of opportunities.

“I haven’t worked in other businesses, but my sense is that with some small-cap funds that have one lead manager, there is only so much of the market they can cover and they may have an inherent bias,” he added.

“Some small cap managers just don’t do biotech or life sciences. Some don’t do resources, some even don’t do tech. And I can’t understand how you can be a small-cap manager and not do tech.

“What we have with a team approach is we cover the whole market and we’re looking for ideas in all areas. We’re quite comfortable having zero weighting in a sector if there is nothing there.

“But equally, we want to have somebody looking at that to know that there’s nothing there.”

While the manager warns against making general statements about the small cap market, he said he is optimistic about the sector as a whole, particularly at the lowest end.

Even though UK mid caps were among the best-performing areas of the market last year, the AIM index has yet to recover from its sell-off in the final quarter of 2018.

Performance of indices over 3yrs

Source: FE Analytics

Stevenson said this can partly be attributed to a hangover from MiFID II, which resulted in a pullback in analyst coverage, as well as the “ongoing ripple effect of Woodford”. However, he said this difficult period has created opportunities.

“Glass half-full, you would say the lagging of small cap and AIM means there is a catch-up to come,” he added.

“We saw in January that mid caps were the worst-performing segment of the UK market as some of the profit for 2019 was locked in. AIM and small cap sold off a bit and then flatlined, so there is a prospect of closing some of that gap going forward.

“But if you are glass half-empty, you can say the structural illiquidity risk is here to stay in the eyes of fund buyers.

“We find when we’re doing due diligence questionnaires for the larger fund buyers now, the segment on liquidity has just extended and extended.

“To a certain extent, the horse has bolted – post-Woodford, they are concerned. But if you’re a small-cap manager, liquidity risk is something that you have had to look at on a daily basis your entire career. It’s not something new.”

Data from FE Analytics shows TB Amati UK Smaller Companies has made 413.37 per cent over the past decade, compared with gains of 249.35 per cent from the IA UK Smaller Companies sector and 157.29 per cent from the Numis Smaller Companies Plus AIM (ex IT) index.

Performance of fund vs sector and index over 10yrs

Source: FE Analytics

The £429m fund has ongoing charges of 0.92 per cent.

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Data provided by FE fundinfo. Care has been taken to ensure that the information is correct, but FE fundinfo neither warrants, represents nor guarantees the contents of information, nor does it accept any responsibility for errors, inaccuracies, omissions or any inconsistencies herein. Past performance does not predict future performance, it should not be the main or sole reason for making an investment decision. The value of investments and any income from them can fall as well as rise.