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RAM raiding micro caps

Fund management luminaries have recently been espousing the benefits of mega-cap companies and pointing out that they have never been so cheap.

I agree with this and have been topping up such holdings personally but many companies at the opposite end of the size scale are in similar positions.

It has obviously been a rich and bountiful hunting ground for smaller company managers during the last few years. One of the reasons often put forward for their outperformance is that smaller companies are less researched by the analyst community and so, by putting in time and effort, fund managers can find some long-term winners on much cheaper multiples.

The further you go down the market cap scale the more under-researched potential winners you might find.

Unsurprisingly, in the quest for outperformance, fund managers do look in this area but a lot of the top managers today have too much money under management to invest at the very small end of the scale.

To take advantage of these unloved and unknown companies, a number of micro-cap funds have been set up over the last few years. To add to that list, you can now add the Acuity RAM fund, launching in the next couple of weeks.

This is not just another smaller companies fund. The smaller company and VCT team from Electra Partners are in the final stages of completing an MBO and will be known as Acuity Capital, 80 per cent owned by the managers with 20 per cent retained by Electra.

Nick Ross and Judith Mackenzie are the named managers on this fund but Judith is definitely wearing the trousers in this partnership.

She joined the company from Aberdeen this year. At Aberdeen, she focused primarily on investing in stocks quoted on the Alternative Investment Market within the firm’s VCT but she also invested in unquoted transactions. Nick has headed the Electra VCT team since launch in 2001 and initiated the buyout from the wider group.

RAM stands for Real Active Management. Mackenzie and Ross are effectively taking a private equity approach to fund management, unsurprising knowing their venture capital background but one that can really prove beneficial, buying bigger stakes in these small companies and helping the management either to grow the business or to effect a sale that will benefit the fund and other shareholders.

Some of these companies will be bought for a very short time while others exhibit long-term growth potential that they believe can be held for years.

The Acuity RAM fund will be a concentrated portfolio of around 20 to 30 companies, all of which will have a market capitalisation of under £150m at the time of purchase. Some will be the unloved “body bags” – companies that have fallen from grace. Others will be turn-round situations, some special situations and finally there will be more liquid longer-term holdings.

There are no formal percentages in each area but it is likely that around 30 per cent of the portfolio will be growth-orientated companies at the bigger end of the scale, that is, with market caps in the region of £75m to £150m, 30 per cent will be undervalued companies with defined milestones, 30 per cent will be in undervalued active situations. As an example, here, Acuity might be taking a stake to help the company get taken over. The final 5-10 per cent will be in undervalued special situations, which are likely to have market capitalisations of under £20m.

It is expected that most of the companies will be on Aim but they will not be excluding small-cap companies on the main list.

There are 1,600 companies on Aim but many of them would not fit into this portfolio as they would not meet the managers’ quality criteria. An initial screen has reduced the 1,600 Aim listed companies down to around 100 that have a market cap of £100m or less and are on a price/earnings multiple of less than 10.

This initial screen does not work with all companies – turn-round situations for example have strange valuations, but it does break a high number down into a manageable universe.

One of the problems of small cap funds is size. Many managers close funds to maintain the existing investment process and hopefully maintain performance. This fund will do just that and is being capped at £65m.

Many are wary of buying into new funds due to the costs involved and worries over whether critical mass will be achieved. Acuity is aware of this and has agreed that Electra Partners will seed this fund with at least £5m. I believe this is one of those funds where getting in early could prove beneficial. I will be investing as I think this fund will be a long-term outperformer.

Ben Yearsley is senior investment manager at Hargreaves Lansdown


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