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Ken Wotton speaks to Investment week about three hidden gems in the UK small-cap sector challenging their larger peers

The small and mid-cap market is regularly associated with high levels of risk and volatility. However, the reality is vastly different to the perception, particularly in the current market climate. As political uncertainty floods the UK market, many smaller companies are thriving against larger, more cyclical peers.

While large-cap businesses typically are heavily impacted by macro factors, the agile demeanour and niche positioning of smaller companies gives them the potential to navigate more smoothly through broader economic headwinds.

Despite this, smaller stocks still fall under-the-radar due to a lack of research at this end of the market. This tends to mean smaller company stocks trade at a valuation discount to larger, more well-known, peers.

 

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We believe our UK Multi Cap Income Fund adopts a different approach to most of its competitors, with an allocation of more than 80% to the small and mid-cap market. This is especially important, as 55% of forecast dividends for 2018 come from just ten FTSE100 companieswhich has led to high levels of overlap across many Income Funds. This distinct approach helps to ensure we have low correlation to peers, while also offering strong diversification of income.

The allocation to under-researched smaller companies has been beneficial since the launch of our strategy at the end of June 2017. The Fund delivered a return of 19% over its first year2, far in excess of the 6% return for the IA UK Equity Income sector3, and this performance saw the Fund ranked 1st out of 86 funds over the same period, according to Financial Express.

Below, we assess three smaller companies that have helped to drive that outperformance, displaying strong growth potential despite lingering macro anxieties in the UK.

Please note reference to past performance should not be viewed as a reliable indicator of how the investments will perform in the future. The value of investments and/or funds may fall or rise, and investors capital is at risk.

 

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1. Impax Asset Management

Impax is a specialist investment manager with a focus on the environmental and sustainability sectors. There is a growing trend for asset allocators to increase exposure to these sectors, which has the potential to drive asset flows for Impax for a number of years.

It has already achieved remarkable recent growth, with its AUM swelling from £6.7bn to £11.8bn over the past year; the share price has risen in excess of 114% over this period.4

In addition, the recent Pax World Management acquisition gives the group critical mass and distribution in the important US market.

Impax has a business model with strong operational leverage that drives profit margins, cash generation and dividend growth as assets under management scale. The group’s specialist focus in this attractive niche area should drive continued growth and deliver further shareholder value over time.

2. Bioventix

Bioventix is a specialist developer and supplier of antibody technology for the pharmaceutical sector. It produces and licences its technology for use in diagnostic testing and pharmaceutical research, with notable applications in clinical areas such as diabetes and heart failure.

The business has a high-margin intellectual property licensing model – which has delivered consistent profit growth, cash generation and a growing dividend over a number of years. We first invested in Bioventix for our Baronsmead VCT clients in 2013 and added a position in the company for the UK Multi Cap Income Fund at launch last year.

 

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3. Knights

Finally, another hidden gem is Knights, a UK legal services business operating under a commercial structure without an equity partnership. It has good quality earnings streams with diversification across customer, fee earner and an area of legal service – as well as a high degree of repeat revenue from existing customers.

Management has driven a strong growth strategy – combining recruitment of quality regional lawyers, as well as making acquisitions at attractive multiples – particularly when viewed on Knights’ restructured model. Knights achieves high EBITDA margins for the sector, through driving efficiencies in the ratio of fee earners to non-fee earners. Our UK Micro Cap and Multi Cap Income funds participated in the IPO of Knights earlier this year.

 

This article was originally published in Investment Week on 14th August 2018. 



[2] Source Data: FE Analytics, LF Livingbridge UK Multi Cap Income Fund, C share class, Accumulation units, since launch 30 June 2017 to 30 June 2018. IA UK Equity Income Sector peer group performance average calculated over same period.

[3] Source Data: FE Analytics, LF Livingbridge UK Multi Cap Income Fund, C share class, Accumulation units, since launch 30 June 2017 to 30 June 2018. IA UK Equity Income Sector peer group performance average calculated over same period.

[4] From 30th June 2017 to 30th June 2018