Downing Strategic Micro-Cap

DSM’s highly concentrated portfolio could benefit from a wave of M&A…by Ryan Lightfoot-Aminoff

Overview

Judith MacKenzie and Nick Hawthorn, the managers of Downing Strategic Micro-Cap (DSM), focus on companies at the smallest end of the market, typically looking at companies with market caps of less than £150m. The managers take a fundamental, valuation-orientated approach to identifying holdings.

This leads them to have a value bias, in contrast to many peers. When they find these ideas, the managers back them with conviction, resulting in a highly concentrated Portfolio of between just 12 and 18 holdings.

Performance has been challenging for the team relative to the AIC UK Smaller Companies peer group. The managers believe that the recent increase in M&A activity has put the valuations of UK smaller companies back in the spotlight.

There has been one takeover in the portfolio in the past financial year, but the managers have suggested this could be a bigger feature over the next couple of years, as they believe their holdings remain significantly undervalued versus their intrinsic values.

As the portfolio is highly concentrated, any takeover in the portfolio could have a material impact on Performance. By focussing on micro-caps, the managers can take a significant stake in companies, which provides them with the opportunity to have input on their future direction. This means they could encourage firms to accept a takeover if it is in the best interests of them as shareholders.

In January, the board reiterated the date for a potential redemption option for shareholders. This would allow investors the opportunity to request up to 50% of their investment back as cash at NAV, in May 2024.

The board has been active in trying to narrow the Discount of the trust and, since the announcement, this has narrowed further and is now trading in line with the five-year average, having previously traded considerably wider.

Analyst’s View

We believe that DSM stands out for a number of reasons. Firstly, the managers’ focus on micro-caps, with an eye for valuation, means the Portfolio is unlikely to have much overlap with many other trusts in the peer group. This portfolio is also highly concentrated, meaning the managers can interact with their companies, often encouraging changes in leadership and strategy to try and unlock value.

We believe this approach has become particularly pertinent in the wake of increased M&A activity, especially in UK smaller companies. The managers have already encouraged one holding into private hands, resulting in a materially positive impact on Performance. While never a guarantee, we believe there is considerable scope for this to be a feature going forward. This could be especially beneficial in DSM due to the concentrated nature of the portfolio.

The board has also reiterated, and set a date for, a 50%-redemption point. We believe this offers an element of protection for investors. The board has been active in trying to narrow the Discount, which has borne fruit in the past year, and the redemption point could lead to a further narrowing. We think as 31/05/2024 comes closer, investors may better appreciate the potential opportunity to have a cash return, which arguably puts a floor under the discount.

Bull

Highly concentrated portfolio offers strong upside from potential M&A activity
Upcoming redemption point could support further discount narrowing
Value-orientated market has provided tailwinds for relative performance

Bear

High-conviction portfolio equates to concentration risk
Micro-cap investment universe can lead to an illiquid portfolio
Fees are towards the higher end of the peer group

See the latest research on DSM here >

Click to visit:

Disclaimer

Disclosure – Non-Independent Marketing Communication

This is a non-independent marketing communication commissioned by Downing Strategic Micro-Cap. The report has not been prepared in accordance with legal requirements designed to promote the independence of investment research and is not subject to any prohibition on the dealing ahead of the dissemination of investment research.

Commentary » Investment trusts Commentary » Investment trusts Latest » Latest » Mutual funds Commentary

Could benefit from a wave of M&A: Downing Strategic Micro-Cap