The smallest companies on the stock market can be high risk investments. So-called micro caps either make investors lots of money or lose them significant sums if they run into difficulty or go out of business.

We believe anyone with the stomach for micro funds should look at this part of the market, as there are some exciting opportunities to embrace.

A lower-risk – but not risk-free – way of getting exposure to micro caps is to invest in a fund specialising in junior companies. The investment trust side of the funds market has many good micro-cap themed products, in our view. We explore a few well-known names in this article.

The best micro caps offer potential for rapid-paced growth and bumper share price gains.

Their smallness means micro caps have minimal market shares and this underscores their ability to sustain a speedy growth rate, irrespective of the wider macro backdrop. Furthermore, micro caps are often takeover targets.

Benefits of using a fund manager

In order to manage single-stock risk, investors could entrust their cash to a professional money manager – either via investment trusts or other funds like unit trusts.

Fund managers are able to invest across a diversified book of micro caps and spend time meeting management and understanding the business. That gives them an edge over individual retail investors who often only get to learn about a stock from its financial results.

Within the Association of Investment Companies’ (AIC) UK Smaller Companies sector, a number of trusts and investment companies have micro-cap exposure within their portfolios.

They include Standard Life UK Smaller Companies (SLS), managed by Harry Nimmo; and Strategic Equity Capital (SEC) which is managed by Stuart Widdowson.

Other names worth exploring are the Gervais Williams-managed Miton UK MicroCap Trust (MINI) and the River & Mercantile UK Micro Cap Investment Company (RMMC).

Cream of the crop

River & Mercantile UK Micro Cap is managed by bottom-up stock picker Philip Rodrigs who has delivered benchmark-beating growth in net asset value NAV since the fund’s launch in late 2014. A key reason behind this good performance has been a steady run of portfolio takeovers.

Rodrigs informs Shares that to access the fantastic array of micro-cap opportunities, ‘the only proper way is to have a fixed pool of capital’. That’s the domain of investment trusts.

He runs a focused portfolio of between 30 and 50 holdings (45 positions at last count).

‘It is all about applying the “PVT” investment philosophy at River & Mercantile, which is Potential, Valuation and Timing,’ he explains.

‘We’re looking at the potential for a company to create shareholder value, but we want to access that high potential at a cheap valuation and at the right time,’ says the fund manager.

‘We’re looking at timing where there’s a catalyst of positive change – for example the company has surprised investors with better than expected profits and investors are responding with the share price turning upwards.

‘And if we have that catalyst in combination with strong potential and a cheap valuation, then we believe that delivers better outcomes over the long term.’

Rodrigs insists that by applying a focused approach, he is roughly investing in the top 10%, in his opinion, of the available opportunities in the addressable universe. ‘We’re really going after the cream of the crop.’

The River & Mercantile manager says he prefers investing in cash flow positive businesses. He wants companies that can fuel their own growth by creating cash and reinvesting cash into further enhancing their growth.

Philip Rodrigs,

River & Mercantile UK Micro Cap

Big data and digitisation

About 40% of his portfolio is invested in global technology service companies that have their primary business focused on digitisation and big data.

Digitisation of laborious manual data processing tasks is driving growth for high-flying Blue Prism (PRSM:AIM), the robotic process automation leader and the fund’s best third quarter performer.

Other portfolio holdings include email marketing software firm DotDigital (DOTD:AIM) and Swallowfield (SWL:AIM), the contract manufacturer for face creams and lipsticks. The latter is augmenting its business by creating and buying in brands backed by digital marketing.

‘These days, you can go onto Facebook or Instagram and in a much smaller way, reach the target audience far more cheaply,’ explains Rodrigs. ‘That means small niche brands are growing very robustly and that’s creating a lot of value for Swallowfield.’

Meanwhile, Big Data underpins the ‘ferocious growth’ being delivered by mobile advertising platform Taptica (TAP:AIM), able to place mobile adverts to the most likely interested recipients, thereby enhancing the performance of its clients’ advertising campaigns.

‘We’re talking triple digit growth for this company,’ says Rodrigs. ‘And even though it has gone up so much, because it is growing so fast, I continue to be very excited about Taptica.’

Turnaround potential

Rodrigs has faith in the profit recovery potential of women’s value fashion retailer Bonmarche (BON), which has disappointed with a string of weather-related profit warnings.

‘For me, it has very attractive positioning for a clothing retailer, as very few retailers dedicate themselves to the fastest growing demographic in the UK, which is the older population 50-plus,’ says Rodrigs.

He notes new boss Helen Connolly should benefit from upgraded IT systems, (hopefully) more favourable weather and the fact Bonmarche should benefit from its primary competitor going bust, being BHS. (JC)

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