Buying small-cap shares can be a good way of making money in the long term if you are prepared to ride a bit of short-term turbulence. It can also be good way of losing money. Such companies often are not much researched by analysts and many believe that changes coming at the start of next year from Mifid II’s market regulatory reforms will mean that there will be even less research thereafter.
Downing has been running an open-closed cap fund for some years, achieving a good average return. In May it floated Downing Strategic Micro-Cap, a quoted vehicle, raising £54.5 million to invest in smaller stocks with a market worth of £150 million or less.
The trust intended to take relatively large holdings in companies, researching them in the same way that a private equity investor would and being highly engaged with the management. So far, five investments have been made, with about a third of that capital deployed. The trust expects to have spent the bulk of the money by next spring and there is the option, contained in the prospectus, to raise about the same amount again in due course when it is needed.
The biggest investment is in debt, in fact a £7.25 million loan note taken out to fund expansion at Real Food Group. This makes cake decorations and the like and had a serious upset in the summer, just as Downing took its stake, with a profit warning and the departure of management. It has a strong market position and is a good contender for a takeover by a larger group.
The others include Gama Aviation, which serves aviation groups around the world and enjoys strong cashflow. Good management and cash generation are two of the trust’s main criteria for investment. Gama is in a highly fragmented market with good prospects for consolidation.
Redhall is a niche engineer with good prospects for work in the nuclear industry. Downing does not like natural resources companies, which can be difficult to understand, while technology stocks often do not enjoy that strong cash generation.
There is no dividend and no intention to pay one, although there is the prospect of future one-offs, for example from any gains if a stock is taken off the market by means of a takeover bid.
For now, Downing is in investment mode. This is a trust to buy for the longer term and for capital appreciation as undervalued companies are identified.
MY ADVICE Buy
WHY This is a bet on the ability of the highly experienced team to find undervalued small companies over the long term
XP Power
When a company has performed as well as XP Power has over the past couple of years, one is inclined to ask what could go wrong. XP makes unexciting but essential products that control power for a range of industries. The company is well followed by retail investors for its habit of paying four quarterly dividends. Its market capitalisation stands at £594.36 million after a rise in the share price of 229p to £30.99 on a third-quarter trading update that was much better than expected.
XP bought an American maker of radio frequency power converters in September and has indicated that further deals are expected. The update said that full-year performance would exceed expectations, after a 21 per cent rise in revenues and a 30 per cent rise in orders in the first nine months, both at constant currency rates.
The customer and product bases are wide-ranging, with no undue reliance on any one. As to what could go wrong, production is looking a little constrained and work started only last week on a third factory, in Vietnam. The shares sell on 22 times earnings and investors who have taken this column’s advice in the past and bought might think about taking some profits.
MY ADVICE Take profits
WHY Shares have come up a long way and are highly rated
ICG Enterprise Trust
ICG Enterprise Trust, a private equity investment vehicle, was known previously as Graphite Enterprise Trust before being taken on in February last year by Intermediate Capital Group, which has almost three decades of experience in private equity. It is held mainly by retail investors and one of the first things that ICG and the trust did was to regularise dividend payments to ensure that those investors received a reliable income stream, with a total of at least 20p promised for the current year to the end of January.
The half-year to the end of July was an unusual one, with proceeds from disposals of £117 million at good returns far outstripping the £65 million that could be invested. This was distorted by the sale of the biggest investment, Micheldever, a tyre distributor acquired by a trade buyer, bringing in £36 million. More typically, as over the past 12 months, cash coming in from realisations has been balanced by cash going out.
The move to ICG allowed a wider range of investments to be taken on. The trust invests directly, jointly with ICG itself or in other private equity funds. The record since the switch is a strong one, with an 8.7 per cent total return on net assets in the first half. About 23 per cent of the portfolio is in the United States, with plans to increase this to 35 per cent to 40 per cent in the medium term, again with help from ICG.
The shares, up 24p at 785p, have performed well since the changeover, but still sell at about a 16 per cent discount to net asset value, which should narrow further in due course.
MY ADVICE Buy
WHY Further potential from future investments
And finally . . .
Columbus Energy Resources is a small Trinidadian oil and gas producer formerly known as LGO Energy, which has relaunched with new management. The managers have taken part in a fundraising to accelerate its programme for 2018 and seek out M&A opportunities. Cashflow should be positive by the end of the year. The company also has attracted its first institutional investor, Schroders, which is putting in £3 million for a 10 per cent stake, an unusual investment in an area largely shunned of late.
