Miton UK Microcap Trust chairman pleased with MINI’s strong longer term performance

Miton UK Microcap Trust plc

Miton UK Microcap Trust plc (LON:MINI) has announced its annual results for the year ended 30th April 2022 and the publication of its annual report and accounts for the same period, which includes the notice of its 2022 Annual General Meeting.

HIGHLIGHTS

Results for the Year to 30 April 2022

·      Over the year, the Ordinary share NAV fell from 104.83p on 30 April 2021 to 91.05p on 30 April 2022, a negative total return including dividends reinvested of 13.1%.

·      The Ordinary share price fell from 104.50p at 30 April 2021 to 86.50p at 30 April 2022, a negative return of 17.2%. As at close of business on 15 July 2022, the closest date to this Report, the Ordinary share NAV was 72.09p and the share price was 67.20p.

·      The net Revenue return was a positive return of £159,000 this year, or 0.15p per share. This compares to a loss of £169,000 last year, or (0.14)p per share.

·      The Company offers all investors the opportunity to redeem their shareholding each year, which has the advantage of clearing any overhanging sellers and is designed to ensure that the market price of the Company does not deviate too far from the underlying NAV. Redemption requests in relation to 14,614,199 ordinary shares, or 13.3771% of the Company’s share capital, at 30 April 2022, were received for the 30 June 2022 Redemption Point and are not reflected in the summary below. The redemption mechanism is explained further within the full Annual Report.

·      The Company does not have a formal benchmark but, for comparison, it is intended that the return on the Numis 1000 Index and the Morningstar Investment Trust UK Smaller Companies sector will be published on the monthly factsheet and in the Company’s annual and interim reports. Returns, however, may diverge from any of these indices for a significant period.

Summary of Results

  Year to30 April2022 Year to30 April2021
Total net assets attributable to equity shareholders (£’000)99,475116,651
NAV per Ordinary share*91.05p104.83p
Share price (mid)86.50p104.50p
Premium/(Discount) to NAV*(5.00)%(0.31)%
Investment income£1.0m£0.7m
Revenue return per Ordinary share0.15p(0.14)p
Total return per Ordinary Share*(13.77)p49.51p
Ongoing charges#*1.41%1.60%
Ordinary shares in issue109,253,560111,274,758

*Alternative Performance Measure (“APM”). Details provided in the Glossary of the Annual Report.

#The ongoing charges are calculated in accordance with AIC guidelines

CHAIRMAN’S STATEMENT

Overview

This report, representing the fully audited results for the Company for the year ending 30 April 2022, is my first as your chairman. Andy Pomfret, my predecessor, stepped down, as planned, on 31 December 2021. As we reported in an RNS at the time, the Board would like to formally thank Andy on behalf of all shareholders for directing the Company with such skill and dedication since its launch on 30 April 2015. The Company’s success as a distinctive pioneer in the microcap arena, with an excellent return record, is due in no small part to Andy’s inspired leadership. We wish him well.

Performance

The investment objective of Miton UK MicroCap Trust (MINI), as stated in our prospectus, is to provide Shareholders with capital growth over the long term. MINI has no formal benchmark. Your Company first traded on the London Stock Exchange at the issue price of 50p on 30 April 2015. Over the seven years to 30 April 2022 the NAV Total Return that MINI has produced is 89.05%. This compares with the Numis All Share Index (including Investment Companies) with a return of 42.81% and the Numis Small Cap 1000 Index (excluding Investment Companies) which was up 63.17%. Other comparators for this period include the Numis Small Cap Plus AIM Index (excluding Investment Companies) which produced a 57.34% return whilst the NAV Total Return produced by our peer group was 53.26%.  Overall, therefore, we are pleased with MINI’s strong longer term performance.

Total Returns since launch in April 2015

 %
Numis All Share42.8
Numis 1000 Index63.2
Numis Smaller Companies ex ICs + AIM57.3
MINI NAV89.1

Source: Premier Miton, Numis

Over the past 12 months to 30 April 2022 we have lagged our comparators producing a NAV Total Return of a negative 13.14%, whilst the Numis Small Cap 1000 Index (excluding Investment Companies) fell 9.06%, our peer group1 was down 6.95%, the Numis Small Cap 1000 Index (excluding Investment Companies) registered a negative 5.78%. Over the year to April 2022, the strong dollar and buoyant commodity prices have favoured the largest stocks, thus the Numis All Share Index (excluding Investment Companies) rose 5.26%.

You may wonder why it is that we use the Numis indices in all our communications. The answer is a simple one: we are trying to save our shareholders money as the FTSE indices charge a significant amount if we use their data. The Numis indices were launched at the start of 1987. They have been published continuously for 34 years, whilst they also have a 32-year back-history to 1955. Since their launch, the Numis indices have provided the definitive benchmark for monitoring the performance of smaller UK companies and we are delighted to be using them for comparison purposes. Your directors are pleased with MINI’s long term performance as it is handsomely matching its objective.

Despite small caps being buoyant in early 2021, there was excess of issuance in the second half of 2021 and small cap share prices drifted with small cap stock market indigestion, made worse by the invasion of Ukraine by Russia on 24 February 2022. In the absence of small cap momentum, MINI traded at an average discount of 6.2% over the year to April 2022, and at a 4.0% discount since IPO given the Brexit uncertainties and then the Covid-19 pandemic. 

Generally, when small caps are out of favour, MINI trades closer to NAV than most other small cap investment trusts. Since the autumn small cap stocks in the UK have been on a relentless downward trend. Small cap stocks tend to get caught in the early stages of a bear market as selling is liable to be indiscriminate and the liquidity in these stocks can be thin. We believe that MINI is well positioned as its portfolio of investments is largely composed of companies which not only generate profits, but also have robust balance sheets. At the end of April 2022 MINI had investments in 137 quoted companies, with a weighted average market cap of £101mm, and minimal debt overall. The weighted average Price/Book ratio of the portfolio was 1.4x, considerably less expensive than the 1.8x for the UK market as a whole and with a dividend yield of 0.94%.

Earnings and Dividends

Earnings for the year were 0.15p per share (2021: 0.14p per share) on the revenue account.  Earnings on the capital account consisted of a loss of 13.91p per share (2021: a gain of 49.65p per share). Earnings on the revenue account remain depressed as micro-cap companies would rather invest in their businesses than reward shareholders at such an early stage in their corporate lives. Revenue this past year, however, was boosted by a special dividend of 50p from CML Microsystems, which added £74,000 to the account. As far as setting the dividend is concerned, the Directors aim to give the Investment Manager maximum flexibility to follow whichever course will lead to the best results for our shareholders. Your Directors regard the dividend as a useful by-product of the investment process but not a target.

Our ambition is to continue to pay a small dividend but rest assured that we will not plunder the capital account in order to maintain it.  This year, your Board is recommending a final dividend of 0.15p per Ordinary share.  Subject to approval by shareholders at the AGM, this will be paid on 30 September 2022 to all shareholders on the register on 2 September 2022.

Board Succession Planning

We were delighted to welcome Davina Walter as a Director of Miton UK Microcap Trust plc on 10 August 2021. We have engaged a firm of head hunters to track down a replacement for Jan Etherden, who has decided to retire from the Board by the end of 2022. Our intention is to keep the Board at four members, but there may be short periods when the number of directors rises to five to ensure an efficient handover of responsibilities.

We are aware of the recent changes in that the FCA has published a Policy Statement on Diversity and inclusion on company boards and executive management (PS22/3).  These change the Listing Rules and the Disclosure Guidance and Transparency Rules. The new rules include requirements for companies subject to Chapter 15 of the Listing Rules to include a statement in their annual reports and accounts as to whether the company has met the following targets on board diversity as at a chosen reference date within its accounting period:

·              At least 40% of individuals on the board are women;

·              At least one of the senior positions on the board is held by a woman, and

·              At least one individual on the board is from a minority ethnic background

As an externally managed investment trust, the Company does not have a CEO or CFO and therefore the two relevant senior positions are Chair and Senior Independent Director

We have met the first point and we hope, within the next few years, to transition to a position where the last two points are also complied with. The Board is conscious of the directive which limits the term of directors, aside from the chairman, to nine years. As the company has been in existence for seven years, succession planning has been an important topic and we are trying to ensure a staggered departure of directors so that our successors are not faced with everyone’s term coming up at once.

Directors’ remuneration

The directors are entitled to an increase in their fees by the percentage uplift in CPI each spring. The figure which applies to fees from 1st May 2022 is 9%. Recognising the need to show restraint, the directors have unanimously agreed to apply a 4.5% uplift to their fees this year.

Responsible Investing

It is ironic that those managers who followed environmental, social and governance (ESG) principles to the letter, without any regard to a more subtle approach, will have performed poorly over the last few months since oil stocks, mining stocks, tobacco stocks and defence stocks have all performed well thanks to Putin’s ill judged invasion of Ukraine. Happily, the Investment Manager has taken a nuanced stance to ESG investing, and has not shied away from all these sectors. Within the oil sector, for instance, MINI has investments in 10 carbon based energy holdings, including Independent Oil and Gas, which has a zero carbon production footprint, thanks to using previously redundant gas pipelines, and unmanned mini-rigs on the gas fields operated from the shore via electric cables. MINI’s Investment Manager has increasingly focused on integrating ESG factors alongside financial factors in the investment process including decisions, as genuinely active investors, to hold individual underlying investments in the portfolio. The Investment Manager believes this is important enabling them to deliver strong and durable performance and meet their broader investment responsibility.

Share Issuance

A total of 650,000 new shares were issued during the course of the year at an average of a 1.02% premium to the prevailing Net Asset Value (NAV) in May 2021, when these shares were issued. Your Directors are keen to grow the size of the Company and look to issue shares when the share price is at a sufficient premium to NAV.  This exercise keeps the premium in check, so as to ensure that no one pays too high a price for the underlying assets, whilst it also ensures adequate liquidity to those wanting to acquire shares. Issuing shares at a premium enhances the NAV, benefitting existing shareholders.  This also dilutes MINI’s fixed costs, thus lowering the Ongoing Charges Ratio (OCR). We will be seeking approval at the AGM in September to renew this useful facility. 

Share Redemption

Once each year, traditionally at the end of June, your Directors choose to offer the facility for shareholders to redeem their holdings in part or whole, at or close to the prevailing NAV. The Directors have offered this facility again this year and the timetable is laid out within the Annual Report. In fairness, as the amount of shares tendered reached 13.3771%, the Directors agreed to form a separate Redemption Pool and it may take a number of weeks to liquidate this pool appropriately.

The Board intends that the 2023 Redemption Point will be moved from 30 June 2023 to 31 October 2023 to align with the interim report. The Board considers this to be in the best interests of all shareholders.

Annual General Meeting

The Annual General Meeting (AGM) of the Company will take place at 11am on Tuesday 27 September 2022 at 1 Finsbury Circus, London, EC2M 7SH and your Board looks forward to this annual opportunity to meet shareholders.  In addition to the formal business of the AGM, there will be a presentation by the fund managers on your Company’s performance and prospects.

The formal notice of AGM can be found within the Annual Report.

Outlook

The investment outlook looks pretty bleak with inflation approaching double digits, rising interest rates (admittedly from multi-century lows), stalling growth, fears of recession and the worst conflict raging in Europe since 1945 with the possibility of further escalation. At the time of writing one might almost be pleasantly surprised at how resilient markets have been. You might well be forgiven for thinking one would be unusual to even contemplate investing in a portfolio of microcaps. However, there are a useful number of factors which might make such a thought compelling.

First, ever since MIFID II was sprung on the market at the start of 2018, there has been a steady withdrawal of investment analysts covering microcaps and small companies generally. Typically, microcaps only have one analyst covering them and that individual is usually from the sponsoring house, whose opinions are often regarded as little more than a marketing ploy. Your Directors remain deeply impressed by the number of companies which the managers of the Trust, Gervais Williams and Martin Turner, manage to meet, physically or remotely, over the course of a year. As dedicated small cap managers, who have been operating in this arena for three decades, their understanding of what makes a successful microcap company is almost unrivalled. There are many ‘gems in the rough’ and your Investment Manager is well placed to identify them.

Secondly, your Investment Manager currently deploys a FTSE 100 put well out of the money, which will help bring much sought after liquidity to the portfolio if the FTSE falls to 6,200 by December 2022. This, coupled with the long lived and dedicated facility to borrow £5m from a leading UK bank, gives the Investment Manager the ability to get hold of funds when stocks are trading at distressed valuations and thus is able to take advantage of such conditions.

Some may think that microcaps are companies of little consequence but many of them are world leaders in their fields and astute leadership can enhance their already dominant positions with sensible infill acquisitions and canny investment.  MTI Wireless, an investment made soon after the Trust’s launch, subsequently rising to become one of the largest holdings, is a good example. It is currently being actively engaged by many of the largest 5G equipment manufactures because its 5G aerials have patented commercial advantages over others. It is a fact that well-chosen microcaps can, and often do, rise by multiples of their original price, and this then brings them into the sights of investment managers who, until this point have eschewed the smallest companies, leading to yet further share price appreciation. Over the life of the Trust there have been numerous stocks that have risen many multiples from their entry cost. Within the portfolio at present there are 63 stocks that are standing above entry cost, of which 14 have at least doubled since purchase, seven that have tripled, and five that have quadrupled, one of which has risen even further. ‘Elephants don’t gallop’ is an old Stock Exchange maxim, but microcaps can fly!

Over recent years your Investment Manager has highlighted why their investment strategy has the potential to deliver excellent returns. They have also outlined how returns can be achieved with portfolio risks that are usefully moderated versus others. Fortunately, to date this strategy has delivered, with MINI’s NAV having risen nearly 90% since issue in April 2015, well ahead of most indices, and with a Beta that has been below the indices and many other competitor trusts. Whilst the current economic and political news flow may have turned decisively negative, your directors believe that MINI’s strategy has the potential to deliver premium returns relative to others. The FTSE100 Index may currently be leading the way, but UK quoted microcaps may also have some good performance ahead and the potential to deliver years of good returns.

Ashe Windham

Chairman

18 July 2022

1The Company’s peer group is the Association of Investment Companies UK Smaller Companies Sector – see Glossary in Annual Report for a list of constituents

INVESTMENT MANAGER’S REPORT

Who are the fund managers of the Trust?

Premier Miton Group plc is an independent, listed fund management company, formed from the merger of Premier Asset Management and Miton Group in November 2019, with a well established reputation for successfully managing UK-quoted smaller company portfolios over the longer term. The Trust’s board appointed Miton Group as Investment Manager when it was first listed in April 2015.

The day-to-day management of the Trust’s portfolio continues to be carried out by Gervais Williams and Martin Turner, who came together as a team in April 2011.

Gervais Williams

Gervais joined Miton in March 2011 and is now Head of Equities at Premier Miton. He has been an equity fund manager since 1985, including 17 years at Gartmore. He was named Fund Manager of the Year by What Investment? in 2014. Gervais is also a board member of the Quoted Companies Alliance and a member of the AIM Advisory Council.

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Martin Turner

Martin joined Miton in May 2011. Martin and Gervais have had a close working relationship since 2004, with complementary expertise that led them to back a series of successful companies. Martin qualified as a Chartered Accountant with Arthur Anderson and had senior roles and extensive experience at Merrill Lynch and Collins Stewart.

Why are the index comparatives used in this report different from those used previously?

When the Trust was first listed in April 2015, the Prospectus set out its prospects with reference to the AIM investment universe, since it was anticipated to include most of the Trust’s portfolio holdings, and the FTSE series of indices is familiar to most investors.

The London Stock Exchange that owns the FTSE Index data has recently concluded that although the Manager pays for a licence for this data, in future this will not extend to its use by the Manager’s clients. Premier Miton also has a licence to use the Numis Index data, and Numis have confirmed that its terms will continue to include the use by Premier Miton clients. Therefore, as outlined in the Trust’s Interim Report, it need not pay the cost of a new FTSE Index licence as it can use Numis Index data as a performance comparator in future.

Since the Trust was first listed in April 2015, the returns of both sets of indices happen to be broadly similar, although there are some divergences over shorter time periods. If anything, the returns on the Extended Numis 1000 Index more closely represent the fluctuations of the Trust universe of UK quoted microcaps, because it comprises the bottom two percent of both LSE and AIM listed stocks. Furthermore, the Extended Numis 1000 Index returns aren’t distorted by the major fluctuations of the largest AIM listed stocks that have occurred over the last seven years.  

What were the main contributors to the Trust’s return over the year?

After the substantial outperformance of quoted microcaps in the year to April 2021, the share prices of UK-quoted microcaps mostly peaked during the year under review. In part, this was related to a large number of corporate fund raisings ahead of the calendar 2021 year-end that exceeded the scale of capital available. Hence, microcap share prices declined at a time when many larger quoted share prices rose.  Thereafter, as inflationary pressures persisted and global asset prices declined in the early months of 2022, microcap share prices reflected the trend and declined further. Over the year the NAV of the Trust declined by 13.1%. This compares with a decline of 5.8% for the Extended Numis 1000 Index over the same period. 

Whilst quite a number of share prices of companies in the portfolio declined, the greatest detractor to returns this year was Accrol Group. As a supplier of toilet rolls, demand has remained consistent. Their problem was that their deliveries became unreliable due to Covid-related staff absence, and given the decline in service levels, their supermarket customers refused to fund the additional energy costs of their factories, at least initially. These issues have been addressed subsequently, and it is expected that Accrol’s profitability will recover. Over the year under review however, its share price fell by 65%, and this fall reduced portfolio returns by 1.4%.

A second example is Avacta, that had also outperformed in the previous year. Whilst it continues to make good progress with potential medical treatments using affimers, it had to suspend manufacturing lateral flow tests for covid as an antibody supplied by one of its partners was not sensitive enough to the Omicron variant. This detracted 1.0% from portfolio returns.

From time to time the Trust’s portfolio is invested in FTSE100 Put options, as their valuations tend to rise dramatically during stock market sell-offs. The Trust held one in 2019, and it rose to a multiple of its cost during March 2020 due to the covid-induced market sell-off. It was sold near the nadir in markets, and the Manager used the cash to buy a number of new portfolio holdings standing at abnormally low share prices, that then went on to enhance the upside of the Trust.  The Manager invested in a new FTSE100 Put option in August and September 2021, and since the FTSE100 Index has held up subsequently, its ‘time value’ has declined. The valuation of FTSE100 Put options can be likened to insurance fees, in that the cover only extends over a defined period (to December 2022 in this case), and as their term to expiry shortens, so does their valuation. This position cost the Trust 1.2% over the year to April 2022.

What are the main factors that have driven the Trust’s return since it first listed in April 2015?

Academic analysis of UK stock market data since 1955 identifies that the best performing group of stocks have been quoted microcaps. When the investment universe is narrowed further, to solely include microcaps standing on undemanding valuations (low Price/Book), the scale of their outperformance is even more marked. With this background in mind, the Trust’s portfolio is principally selected for UK quoted microcaps standing on what we consider to be overlooked valuations at the time of purchase. When these microcaps succeed, their share prices can rise by much greater percentages than most mainstream stocks.

Since the Trust was set up in April 2015, the combination of abundant economic growth (the Chinese economy has been a standout contributor) and appreciating bond valuations (enhanced by QE) have led to substantial stock market appreciation. This favourable trend has been interrupted by the global pandemic and the Russia-Ukraine war, which has led to a reduction in the ability of the global economy to supply, whilst demand has increased with the extra financial stimulus. The mismatch is now reflected in renewed inflation, which traditionally has proved difficult to unwind. Over recent quarters, the past market trends have started to reverse.

The implications of recent news have somewhat overwhelmed investors, and the advantages that UK-quoted microcap stocks have in an unsettled global economy have remained overlooked. Hence, to date, the differentiated potential of the Miton UK Microcap Trust strategy hasn’t been fully evident. Nevertheless, since inception the Trust has delivered some attractive returns despite local headwinds such as Brexit.

For us, the key point is that we remain upbeat about the Trust’s prospects, as outlined in the paragraphs below. Specifically, we believe the Trust’s strategy will continue to deliver premium returns over the coming years, and with changing market trends we also expect there will be fewer other strategies that can rival it. 

How unusual is the UK quoted microcap investment universe?

Prior to a sustained period of globalisation, the returns on mainstream stock markets were often closely related to the rate of underlying inflation. When inflation was problematic some decades ago, listed small and microcaps were one of very few strategies that delivered premium returns, and hence institutions in many countries usually had a weighting in their locally quoted small and microcap companies. 

Over recent decades, asset returns have been incredibly abundant, coinciding with globalisation. Generally, institutional weightings in quoted small and microcap stocks have lost out to other areas that have also performed well. UK quoted small and microcap stocks may have outperformed UK equities over these decades, but most local institutions have scaled back their UK weightings in order to participate in the even stronger international returns.

The UK small and microcap stock market may have shrunk by number of companies, but it has remained viable, thanks to UK government support through dedicated tax exemptions. Quoted small companies and microcaps tend to boost local skilled employment and increased productivity, which ultimately contribute to additional tax take for the Exchequer.

Economic prospects appear limited currently, with the UK economy, in common with others, potentially vulnerable to a recession in the next few quarters. Whilst this will be a challenge for all businesses, quoted microcaps have the advantage that they are normally financed by share capital, and don’t usually have major debt liabilities. Furthermore, many are relatively young businesses operating in immature market sectors with structural growth drivers. Effectively, many of these are less affected by a cyclical downturn. Finally, being quoted companies, if other businesses become insolvent, they can acquire these operations debt free, and often generate additional surplus cash over the coming years, such as Saietta which acquired e-Traction, an electric drive train business, complementing Saietta’s existing electric motor business.

Following the period of globalisation when so much of the agenda was dominated by scale, it is reassuring to note that beyond globalisation, there may be renewed interest in small companies. The UK stock market is almost unique in having retained such a vibrant, wide-ranging universe of quoted microcap stocks.

Number of quoted companies in the UK below and above £150m market capitalisation

No of Companies
<£150m598 Combined market capitalisation £17.5bn
>£150m569 Combined market capitalisation £2,347.7bn

Source: Premier Miton

What are the prospects of the Trust?

Over recent decades, when we have engaged with investors, we have principally highlighted why we believe our investment strategies have the potential to deliver premium returns relative to most others in our peer group and other UK strategies. Alongside, we have also outlined how we consider that this objective can be achieved with portfolio risks that are moderated through a more diverse range of portfolio constituents than some competitor funds. Encouragingly, to date the returns of our funds have generally come through as anticipated. MINI’s strategy for example has delivered premium returns relative to the smaller company indices over the seven years since issue, as well as outperforming the mainstream UK equity indices. This outcome has been achieved despite largely avoiding stocks that were reliant on successive capital top-ups from investors that were popular for much of this period. 

Whilst the current economic and political news flow may have turned decisively negative, we have started to outline to our investors that we now believe that strategies such as Miton UK Microcap Trust plc have the potential to deliver premium returns relative to international comparators as well as many/most others in our peer group. Clearly, this is a very bold statement, and we do recognise that our assessment of future market trends may be erroneous, or that we at Premier Miton may not add as much value as we have in the past through stock selection. Even so, the reason for raising the ante with our investors, is because we consider the current period as being one where many of the past stock market trends are vulnerable to reversing, and that we may be entering a period when new market trends become established. If this assessment is correct, then those early to identify the nature of future trends, may deliver disproportionate outperformance. Equally, alongside the absolute downside risks associated with investments carrying excessive risks, their performance might also be more disappointing than they have been previously. 

In short, if our analysis is correct, then we, as active managers, now need to become hyper-alert to stocks that might be carrying excessive risk, because of the potential scale of absolute downside that they might deliver. Fortunately, within the Miton UK Microcap Trust, we have always actively sought to moderate portfolio risk via a portfolio of numerous holdings well diversified by business or sector, so that any individual disappointments are more limited in scale. Furthermore, we have also actively sought to select stocks with relatively strong balance sheets that are, in our view, well placed to generate significant surplus cash over the coming years. Clearly, this doesn’t automatically imply that the Trust’s portfolio will not have some holdings that are found in time to be carrying excessive risk, but hopefully it does imply that these should turn out to be a relatively small proportion of the stocks that we own.

Additionally, the characteristics of the UK stock market generally contrast with those of most other developed economies. Specifically, the UK has a preference for businesses that invest in projects generating a stream of incremental cash surpluses, in contrast to those that invest at greater scale in the hope that they can come to dominate the globe in a particular industry. If the high-ambition stocks succeed, these kinds of investments generate very substantial cash surpluses and supernormal returns on their equity – Microsoft, Apple and Amazon are three good examples. But alongside, a much higher proportion of high-ambition stocks never achieve their objective, and with the changing stock market trends currently, they now risk getting caught between two stools. In anticipation of the prize, they often build up a business with substantial costs, but with the changing economic trends they may never get sufficient sales to fund their cost base. If equity capital becomes short stocks such as these, running negative cash flows are likely to become very vulnerable.

Furthermore, we fear that the prospective economic downturn may be associated with a major squeeze in corporate profit margins, given the inflating costs of inputs such as energy, supply chains, labour, interest rates, and taxes. So high-ambition businesses already running negative cashflows prior to the downturn may find their funding position turns out to be even worse than expected. The bottom line is that we believe that the risks of investing in many UK-quoted companies are helpfully much less than, for example, in many US-quoted companies. In time, if this is correct then UK portfolios such as that of the Miton UK Microcap Trust might become a more important source of added value, given that with the change in market trends there may be a paucity of alternatives.

We need to underline that the analysis outlined above is still considered controversial. At present few investors have significantly changed their behaviour, and are still relying on prior market trends persisting. Despite the drawdown on strategies investing in high-ambition stocks, it seems few asset allocators have yet significantly amended their positioning. Effectively to date, shareholders taking profits are still being matched by those looking to invest further capital, motivated by the lower entry price. If market trends are changing, we anticipate that open-ended strategies investing in high-ambition stocks will continue to deliver disappointing returns and in time they are in danger of becoming overwhelmed by liquidating investors who outweigh those investing.

If there is a liquidation hiatus to come, smallcap investment trusts have major advantages. Being closed ended, their share price discount to NAV takes the short-term strain if selling shareholders disproportionately outweigh the buyers. Discounts to NAV bring in new investors over time, so that overhanging sellers can clear. In contrast, when liquidating investors exceed the ability of an open-ended fund to sell assets in the stock market, then they are often obliged to sell their best holdings, so the quality of the underlying portfolio degrades. Unfortunately, such a move often prompts asset allocators to become even more purposeful in the selling of their disappointing strategies, almost irrespective of their valuation or prospects. Furthermore, since asset allocators also hold a proportion of assets that aren’t readily realisable, such as private equity funds, any selling pressure tends to be concentrated in their more conventional funds.

In short, whilst we are very upbeat about the potential for the Miton UK Microcap Trust strategy as market trends change, we anticipate that there may be period of stock market turbulence between now and then. One of the key risks, as we see it, might be characterised as the potential for a build-up of wholesale institutional liquidation selling, as the change in market trend is recognised, and eventually becomes the consensus.

We note that already there are signs of market stress. Normally, a combination of a rise in the US Dollar exchange rate and a decline in bond valuations is associated with an improvement in the valuations accorded to banks. The fact that this is not happening at present may be related to an expectation that central banks are set to withdraw financial liquidity further in the coming months as they raise interest rates, and potentially introduce bring Quantitative Easing to an end. The current lockdown in China may calm commodity prices in the coming months, but only at the expense of a further reduction in the ability to supply, potentially accelerating corporate financial tensions. 

However, the risk of a wholesale liquidation wave within microcaps is fortunately quite limited.  Most institutions have progressively reduced their UK weightings to relatively modest levels over the last three decades, so most are already carrying underweight holdings in the UK stock market. And almost all of the capital they still hold in the UK is focused on mid and large cap equities – few have any real weighting in UK-quoted small and microcaps. And furthermore, any UK-quoted small and microcap exposure that they might have, is typically focused on stocks that may need further capital support to achieve their objectives. Hence, any potential liquidation surge in the UK stock market is unlikely to directly affect the Trust’s portfolio, because institutions have so little overlap with it.

Lastly, the scale of the ‘hiatus’ risk is positively correlated with the trust’s holding in the FTSE100 Index Put option, and its valuation might rise proportionate to any notional liquidation surge. In short, the key point is that we are currently very vigilant about market risks. And, whilst the FTSE100 Put option may have detracted from portfolio returns recently given that the FTSE100 has been resilient to date, we consider its ability to generate surplus cash should market trends become very unsettled really valuable at present given the scale of the adverse capital market risks around.

Gervais Williams and Martin Turner

18 July 2022

PORTFOLIO INFORMATION

As at 30 April 2022

* Source: Thomson Reuters. Dividend Yield based upon historic dividends and therefore not representative of future yield.

Portfolio as at 30 April 2022

RankCompanySector & main activityValuation £’000% of net assetsDividend Yield %
 
1MTI Wireless EdgeTechnology2,5892.63.7
2Afritin MiningBasic Materials2,1682.2
3Live Company GroupConsumer Discretionary2,1372.1
4TotallyHealth Care2,07721.7
5Saietta GroupConsumer Discretionary1,9241.9
6Frontier IP GroupIndustrials1,8651.9
7Corero Network SecurityTechnology1,8111.8
8AferianTelecommunications1,5541.62.2
9KistosEnergy1,5291.5
10Atlantic LithiumBasic Materials1,4851.5
Top 10 investments 19,13919.1 
11Caledonia MiningBasic Materials1,3911.54
12SupremeConsumer Staples1,3751.5
13CT Automotive GroupConsumer Discretionary1,3611.5
14Pressure TechnologiesIndustrials1,3161.3
15Capital LimitedBasic Materials1,2941.32.9
16Cyanconnode HoldingsTelecommunications1,2431.2
17Jubilee Metals GroupBasic Materials1,2241.2
18Tirupati GraphiteBasic Materials1,1511.2
19Van Elle HoldingsIndustrials1,1401.1
20Centralnic GroupTechnology1,1401.1
Top 20investments 31,77432 
21IOGEnergy1,1361.1
22Avacta GroupHealth Care1,1151.1
23TrufinFinancials1,0851.1
24TharisaBasic Materials1,0681.14.7
25Braemar Shipping ServicesIndustrials1,0591.12.6
26Brighton Pier GroupConsumer Discretionary1,0301
27LamprellEnergy1,0211
28FeedbackHealth Care1,0101
29Jadestone EnergyEnergy1,00611.4
30Accrol Group HoldingsConsumer Staples1,00012.2
Top 30 investments 42,30442.5 
Balance held in equity investments 52,51852.8
Total equity investments investments94,82295.3
Listed Put Option
FTSE 100 – December 20228020.8
Other net current assets3,8513.9
Net assets  99,475100

* Source: Thomson Reuters. Dividend Yield based upon historic dividends and therefore not representative of future yield.

Portfolio as at 30 April 2022

Portfolio exposure by sector (%)£95.6 million
Basic Materials20.9
Industrials13.9
Technology12.4
Energy12.4
Consumer Discretionary10.9
Financials8.9
Health Care8.4
Consumer Staples4.0
Telecommunications3.1
Oil and Gas2.2
Real Estate1.7
Utilities0.9
Media0.3
Actual annual income by sector (%)£1.0 million
Financial Services30.6
Technology20.3
Basic Materials14.8
Industrials11.4
Consumer Staples4.5
Health Care4.4
Consumer Discretionary4.3
Telecommunications3.5
Energy3.1
Real Estate3.1
Net asset by asset allocation (%)£99.4 million
AIM69.1
Main Market24.5
Cash3.7
Warrants and Placing1.1
FTSE 100 Option0.8
Debtors and Creditors0.5

DIVIDEND RECOMMENDATION

The Directors have recommended the payment of a final dividend in respect of the year of 0.15 pence per Ordinary Share, payable on 30 September 2022 to shareholders who appear on the register on 2 September 2022.  The ex-dividend date will be 1 September 2022.

NOTICE OF ANNUAL GENERAL MEETING

The seventh Annual General Meeting of the Company will be held on 27 September 2022 at 11.00 am at the offices of Stephenson Harwood LLP, 1 Finsbury Circus, London, EC2M 7SH.  The formal Notice of AGM can be found within the Annual Report.

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