A number of investment trusts holding UK micro-cap equities could be set for a re-rating, according to Miton's Nick Greenwood and Charlotte Cuthbertson.
The pair, who run the Miton Global Opportunities trust of investment trusts, told Investment Week they had recently bought a quartet of UK micro-cap trusts trading on double-digit discounts in anticipation of the out-of-favour asset class finally getting some relief.
Until recently, the £77m trust, which aims to exploit inefficiencies in the investment trust sector by buying companies in more esoteric asset classes trading on wider-than-warranted discounts, has been very light UK stocks, said Greenwood.
"The pound falling and the UK underperforming has been useful and we have had a great two or three years," he said.
But he does not expect this to continue, despite Brexit uncertainty rumbling on.
While UK shares have generally advanced in 2019, "it's been noticeable that micro caps have struggled", said Greenwood. "If they have been [trading] well, they have just about been holding their share price; if they have had a disappointment, you can just make up a number - [their share price is been] slashed."
The call on small-cap UK stocks is very much valuation-based, the managers said. The four trusts they recently bought trade on double-digit discounts, while Miton's own UK Microcap trust, run by Gervais Williams, is almost trading at par.
Two of the trusts chosen, River & Mercantile UK Micro Cap (RMMC) and Downing Strategic Micro Cap, are both currently at much wider discounts to net asset value - 16.98% and 12.86% respectively - than their 12-month average of 9.94% and 0.99% respectively, according to Morningstar data.
Before former manager Philip Rodrigs left in February 2018, RMMC had been trading at a premium of 11%. It immediately slipped to a 6% discount and has not recovered. But Cuthbertson said they were comfortable with how new manager George Ensor was running the portfolio.
The other two trusts in the basket are Gresham House Strategic and Henderson Opportunities, with the latter being an all-cap portfolio, but featuring a lot of micro caps.
Greenwood said many of the City's larger institutions have become so big they can no longer buy £50m to £150m companies. This has led to some micro-cap firms trading on 8x price-to-earnings (P/E) ratios.
If the City will not buy them and their valuations continue falling, then they will be acquired by their larger competitors, Greenwood said.
"If you see your nearest rival down to a P/E of five and a yield of 8% why not just go and buy the entire company and merge it?" he asked.
Cuthbertson also highlighted this was confirmed by colleague Williams, who is responsible for Miton's micro-cap strategies. "He said he is now starting to see some takeover bids in the smallest area because they're just so cheap," she added.
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