Miton UK MicroCap Trust plc (LON:MINI) has presented the Annual Financial Report for the year ended 30 April 2021. The full Report and Accounts will be available via the Company’s website, www.mitonukmicrocaptrust.com, or by contacting the Company Secretary on 01392 477500.
Miton UK MicroCap Trust plc is an investment trust quoted on the London Stock Exchange under the ticker code MINI. It is referred to as the Company, MINI or the Trust in the text of this Report. The Board, which consists of five independent Directors, appoints the Investment Manager and is responsible for monitoring the Trust’s performance.
RESULTS FOR THE YEAR TO 30 APRIL 2021
· Over the year, the Ordinary share NAV moved from 51.33p on 30 April 2020 to 104.83p on 30 April 2021, a total return including dividends reinvested of 104.4%.
· The Ordinary share price moved from 43.35p at 30 April 2020 to 104.50p at 30 April 2021, a total return including dividend reinvested of 141.5%. As at close of business on 2 July 2021, the closest date to this Report, the Ordinary share NAV was 103.20p and the share price was 94.00p.
· The net Revenue return was a loss of £169,000 this year (0.14p) per share as costs were greater than the revenue received. This compares to a positive revenue return of £81,000 last year, or 0.06p 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 2,671,198 ordinary shares, or 2.4% of the Company’s share capital, at 30 April 2021, were received for the 30 June 2021 Redemption Point and are not reflected in the summary below. The redemption mechanism is explained further below.
· The Company does not have a formal benchmark but, for comparison, it is intended that the return on the FTSE AIM All Share 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 may diverge from any of these indices for a significant period.
|30 April 2021||30 April 2020|
|Total net assets attributable to equity shareholders (£’000)1||116,651||71,011|
|NAV per Ordinary share*||104.83p||51.33p|
|Share price (mid)||104.50p||43.35p|
|Premium/(Discount) to NAV*||(0.31%)||(15.55)%|
|Revenue return per Ordinary share||(0.14)p||0.06p|
|Total return per Ordinary share*||49.51p||(4.67)p|
|Ordinary shares in issue||111,274,758||138,335,915|
* Alternative Performance Measure (APM) Details are provided in the Glossary below.
# The ongoing charges are calculated in accordance with AIC guidelines.
This report covers the sixth year of the Trust ending 30 April 2021, which was a period of robust stock market recovery as central banks and governments flooded their economies with plentiful liquidity to offset the effects of the Covid pandemic.
Returns over the year
In May 2020, many UK-quoted microcaps started the Trust’s year standing at very overlooked valuations as many investors had steered clear of UK domestic stocks during the uncertain period leading up to the Brexit Agreement. Furthermore, most UK quoted microcap share prices had fallen yet further at the start of the global pandemic.
Over the year to April 2021, global stock markets appreciated robustly. UK smallcap indices performed particularly strongly with the FTSE SmallCap Index (excluding Investment Companies) up 69.5% in total return terms, and the FTSE AIM All Share Index up 59.8%. The Net Asset Value (“NAV”) total return on the same basis of the Trust was 104.6% over the same period, which includes last year’s final dividend payment approved by shareholders at the AGM. This was the best annual performance of the Trust in its six year life.
A proportion of the Trust’s annual running costs are set against revenue (principally dividend income). In the past, these figures have been quite similar in magnitude and it has always been anticipated that capital appreciation would be the principal driver of the Trust’s return. During the year under review, numerous UK quoted companies reduced or ceased paying dividends, so this year the costs were greater than the dividend revenue received. The NAV total return outlined above includes a revenue deficit per share of 0.20p for the year, which compares to a revenue surplus of 0.06p per share last year.
Returns since the Trust was first listed in April 2015
In six years since the Trust was first listed, the UK stock market has been through a fairly turbulent period. From June 2016 onwards, the UK decision to leave the EU initiated a long period of uncertainty. The weakness of UK-quoted microcap share prices was further compounded by the added impact of the global pandemic.
Over the six year period, in capital terms, the FTSE All Share Index has only appreciated 6.0% despite the Brexit agreement in December, although with six years of dividend income its total return over the period was 32.0%. Quoted smallcaps have outperformed this Index, with the total return of the FTSE SmallCap Index (excluding Investment Trusts) being 71.3% and that of the FTSE AIM All Share Index being 84.1% despite the uncertainties over the six year period. The Trust’s NAV total return including dividend income paid to shareholders over the same period was 118.0%.
Since the Trust’s share price reflects the balance of buyers and sellers, when there is an imbalance, the Trust’s share price can diverge from its NAV.
Over the year to April 2021 the Trust’s share price discount to its daily NAV averaged 9.5%. As investors became more upbeat about the Trust’s prospects and the Brexit uncertainties fell away, the Trust’s share price discount narrowed, and the Trust finished the year with its share price much in line with its NAV.
In order to help to address any persistent imbalances between buyers and sellers, the Trust offers all shareholders the option to redeem their shares each year.
This year, redemption requests were made over 2,671,198 shares at the closing date of 2 June 2021. As announced on 30 June, the Board resolved that these shares would be redeemed for cash at a value of 102.38 pence per share, to be settled on or around 14 July 2021.
As announced with the half year results, Bridget Guerin was appointed to the Board from 1 December 2020.
The yield on government debt has progressively fallen over the decades, which has been a tailwind for the share prices of major technology stocks,
growth equities and other long duration assets. Yet over recent months, the prior trend appears to have been breaking down. Whilst global stock markets
have continued to rise this year, the share prices of UK microcaps have tended to outperform ahead of most others.
The recent trend aligns with those of earlier decades, when the mainstream UK indices outperformed the US exchange for an extended period, and the share prices of UK microcaps outperformed substantially. Whilst we shouldn’t necessarily expect UK microcaps to outperform every year, this sector appears well-placed for a period of premium returns.
5 July 2021
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 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 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.
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.
What were the main contributors to the Trust’s outperformance over the year?
The year to April 2021 was a period when numerous share prices around the world recovered from the pandemic setback, and often moved to new highs. The total return on the FTSE SmallCap Index (excluding investment companies) index was 69.5% and the FTSE AIM All Share Index was 59.8%.
Whilst economic conditions were challenging for some companies during the global pandemic, for others the nature of change offered them much greater potential than before. In the case of Avacta for example, they found their affimer technology which may significantly reduce the side effects of chemotherapy in time, was also potentially very suited to use in lateral flow tests for Covid. Synairgen found that their treatments that helped asthmatics combat the cold virus, turned out to be very helpful to lessen the disease for those with shortness of breath due to Covid.
The abrupt reduction in demand during the pandemic-induced recession, followed by an equally abrupt renewed surge of demand with the economic stimulus, has led to shortage of certain materials, such as copper, leading to a very strong share price appreciation of Jubilee Metals in the year. The appreciation of asset prices was particularly evident amongst cryptocurrencies, and this led to a very substantial rise in the share price of Argo Blockchain.
One of the features of quoted microcaps, is that they start with modest market capitalisations. The potential upside from the changes in their markets can drive up their share prices by multiples of the price at purchase. The four stocks above, contributed over 27% of the Trust’s total returns of 104.4% during the year to April.
Clearly there were some holdings that detracted from the Trust’s return during the year. The most disappointing was Kromek Group, a company which is improving the images of medical scanners, and also identifies radioactive substances for the security forces. In the case of Kromek, they were unable to deliver a major order due to the pandemic travel restrictions, so the potential cash payback has been deferred. The Trust has largely exited from the holding, although it still detracted 0.9% in the year. There were not many other significant detractors, although collectively 7 Digital, Tekmar Group, Microsaic Systems and TP Group detracted 1.0% from the Trust’s return in the year.
Why was the Trust’s revenue per share negative over the year?
The Trust’s strategy particularly seeks to identify quoted microcaps that are well positioned to generate a plentiful surplus of cash in the short to medium-term. As these stocks mature, their cash surpluses put them in a position to either step up reinvestment in their business, or to start paying initial and growing dividends to investors. When the Trust’s holdings succeed and they are in a position to start paying significant dividends to investors, their share prices have normally also risen substantially. In many cases, they have grown to beyond being microcaps, and may have lesser prospects for substantial share price appreciation. Therefore, it is usual for these holdings with dividend income to be sold from the Trust’s portfolio, so the capital can be reinvested in a number of other immature microcaps with much greater potential upside.
Since dividend income contributes the bulk of Trust’s revenue each year, and as the Trust normally takes profits on these stocks, the overall annual revenue is relatively modest. During the global recession, numerous companies opted either to hold back from paying dividends, or in some cases cut their prior distributions, so the Trust’s revenue fell during the year under review.
The Trust’s principal cost is the management fee, with one quarter of this figure expensed against the Trust’s revenue, and three quarters expensed against
the Trust’s NAV each year. Since the Trust’s revenue per share is relatively modest, it was slightly smaller than its revenue expenses to the extent that the revenue deficit per share for the year under review was 0.2p, which compares with a revenue surplus of 0.06p last year. The Directors have determined that the remaining revenue reserves should paid as a dividend to shareholders this year. The Directors have determined that a final dividend of 0.01p should be recommended to shareholders for approval at this year’s AGM. As the revenue per share is in deficit this year, this dividend has been funded from past revenue reserves.
It has always been envisaged that the bulk of the Trust’s return would be via capital appreciation. Over the six years since the Trust was first listed, the aggregate appreciation of the NAV has been 56p, whilst the net revenue per share that funds the Trust’s dividend in aggregate has been just 2p.
What are the main factors that have driven the Trust’s returns since it first listed in April 2015?
In the UK, an analysis of stock market data since 1955 reveals that the best performing group of stocks has been quoted microcaps, and, most especially, when combined with a bias towards those standing on low, overlooked valuations. Whilst stocks with these characteristics have not outperformed continuously, their strong performance has been a persistent trend through a variety of economic and stock market conditions. For this reason, the Trust’s strategy focuses on quoted microcaps that are standing on overlooked valuations. When these succeed, their share prices can rise by much greater percentages than most mainstream stocks, as they did in the year under review.
In the past, the rise of the share prices of overlooked microcaps have often lagged the returns of higher profile, more volatile stocks at times of abundant market liquidity. Yet eventually, the share prices of stocks that are forecast to grow strongly tend to be more vulnerable when economic conditions change. The dot.com boom prior to the millennium is a good example of how much the share prices of stocks that are forecast to grow rapidly can appreciate, but it is also a good example of how quickly and hard they can subsequently fall.
Over the six years since the Trust’s IPO, the share prices of stocks that are forecast to grow rapidly have often been the best performers, although many of the stocks in the Trust’s portfolio on lower valuations have also performed well in the year under review as their prospects greatly improved with the changing economic and market trends of the pandemic. Furthermore, to some degree, as the open-ended nature of the Brexit uncertainty has come to an end, investors are more willing to contemplate investing in UK quoted microcaps.
Overall, we believe that the true potential of the Miton UK Micro Cap Trust strategy has not yet been fully evident. Even so, the Trust’s NAV total return over the six years to April 2021 was 118.0% which equates to an annualised total return of 13.9% per annum. This compares favourably with the returns on the various UK smaller company indices.
Although the Trust has delivered a major increase in NAV over the last year, we continue to believe that the prospects for a strategy seeking to participate in the outperformance of UK quoted microcaps standing on overlooked valuations, is still overdue a period of performance catch-up compared to stocks that are already standing on elevated valuations because they are forecast to grow strongly.
How is the climate change agenda reflected in the Trust’s portfolio?
Whilst some fund strategies are dedicated to investing solely in low-carbon companies that are already close to meeting the climate change agenda, the interconnected nature of the corporate world means that many of these still have a reliance on others that are less well aligned. Specifically, we believe that the financial markets have a major role in actively engaging with the less-aligned companies. Specifically, each needs to make an assessment of their current carbon footprints and then plan to steadily reduce it in future. Normally, evolving a business towards a zero carbon future, will involve very substantial investment, so access to capital will be an important component of these plans.
As managers of the Miton UK Microcap Trust we have a long history of actively highlighting areas of potential hazard with the management teams of quoted companies, so that they can be considered, and, if they agree with us, the risks moderated. In that regard, we actively quiz management teams as to how they are planning to address the climate change agenda, and often give best practice examples of others’ actions. This strategy does involve investing and engaging with some companies that currently have poor metrics, on the basis that reductions in the carbon footprints of these kinds of companies are essential for the UK economy as a whole to meet its zero carbon commitment.
In our opinion, progressively over time, many of the current activities of businesses will either become unviable as the cost of carbon emissions becomes prohibitive, or customer preferences result in a vertiginous decline in demand. Thus, all companies will need to embrace change and step up investment, so they remain sustainable in all senses of the word. For some, moving ahead of others may well offer commercial advantage, and hence enhanced returns. Conversely, some may misjudge how quickly others respond, and carry the associated downside risks. The bottom line is that the Trust’s portfolio still has shareholdings in all sorts of businesses that we genuinely believe embrace the need for change and, in our view, will be successful at addressing the climate change agenda. If they succeed and progressively lower their carbon footprints, then we believe this progress will not only actively assist the UK to become a low carbon economy, but also deliver premium returns for shareholders as well.
What impact would a sustained pick up in global inflation have on the Trust?
Following the surge of economic stimulus during the global pandemic, it is evident that there are all sorts of industry constrictions that are now leading to renewed inflationary pressures. At this stage, it is unknown whether these bottlenecks will prove to be temporary or long-term in nature.
If inflation does prove to be more embedded, then the yields of long-dated bonds will probably rise, which could weigh on the valuations of all asset prices, including stock markets. At the margin, a rise in long-dated bonds might make it harder for some companies with major debt burdens, or those that operate at a loss over many years, to access borrowings when their current facilities expire. Most of the stocks in the Trust’s portfolio would be largely unaffected, as they tend to have strong balance sheets with little debt and are not expected to be persistently loss making.
If inflation does become entrenched, then at the time of an economic downturn it might reduce the scope for central banks or governments to inject economic stimulus in future. Such a change might put more companies at risk of insolvency. One of the advantages of being listed, is that companies can raise external capital and acquire previously overborrowed, but otherwise viable businesses from the receiver. These kinds of acquisitions often bring in additional skilled staff and generate attractive returns on investment, greatly enhancing the prospect of generating plentiful cash in the future. Sometimes these transactions can be potentially transformative for quoted microcaps, because they can be substantial relative to their diminutive size.
Overall, whilst a sustained increase in inflation would, to some degree, make it harder for nearly all businesses, generally we believe that quoted microcaps have some offsetting factors that could greatly enhance their prospects.
How unusual is the UK quoted microcap investment universe?
Prior to a sustained period of globalisation, returns on mainstream stock markets were not very different from that of underlying inflation. During these decades, institutions actively chose to allocate capital to the UK-quoted small and microcaps universe because they needed to access the premium returns they offered.
During the period of globalisation, however, asset returns of all kinds have been unusually plentiful, so institutional interest for quoted small and microcap stocks was crowded out by larger weightings in long-duration assets such as US technology growth stocks. Over recent decades, many small and microcap stock markets around the world have closed for lack of institutional interest.
In contrast to others, the UK government has sustained the support for a quoted small and microcap exchange via dedicated tax exemptions, because they generate both more skilled employment and increased productivity than mainstream companies, and ultimately contribute additional tax take. Hence, as the ultra-low yields on bonds depress the prospective returns on most mainstream assets, the premium returns on quoted small and microcaps is likely to lead to renewed interest from institutional investors.
Generally, we believe that the prospects for the UK economy may not differ much from others, but the vibrant universe of UK quoted small and microcaps imply its prospective returns could be very different. Almost half of all the companies listed in the UK have a market capitalisation of less than £150m which is a major point of difference for the UK market compared with most others.
What are the prospects for the Trust?
The valuation of government debt around the world has risen considerably, in a trend that has persisted for decades. The valuation of the full range of assets has also increased, with the valuations of numerous technology companies and unicorn stocks probably rising the most. Since the US has so many quoted businesses with rapid growth expectations like these, the valuation of the US stock market as a whole has risen more than others, and it has delivered outstanding returns over recent decades.
The UK stock market mainly comprises companies that tend to grow less rapidly. Hence, the valuation of the UK stock market has not risen as much as the US. Furthermore, the uncertainties of the Brexit over the last five years has also suppressed investor enthusiasm, and so the valuation of all sorts of UK quoted microcaps are still undemanding, even after the recent period of performance catch-up.
Following the global pandemic, the whipsaw in global demand has led to shortages of supply in a wide range of individual products. This has initiated a period of inflation, and the valuation of government debt has peaked out somewhat. The recent reversal in bond valuations tends to favour profitable companies that generate surplus cash, as they have greater resilience than technology companies that often need plentiful capital to fund their growth. The recent period has also favoured younger businesses, as many of these operate in immature sectors, where prospects are less reliant on ongoing global growth. The Trust’s portfolio includes numerous younger businesses that are anticipated to generate substantial surplus cash, and hence the recent economic and market trends have been reflected in a period of substantial outperformance. Specifically, it is reassuring to note just how well the Miton UK Microcap Trust’s strategy can perform at a time of disappointing global growth and rising inflationary pressures.
Inflationary pressures may fluctuate over the coming quarters, and the stock exchanges themselves might oscillate as the market trend of recent decades runs out. In time, we expect the forthcoming market trends to resemble those of the decades prior to globalisation, when UK quoted microcaps substantially outperformed. The Miton UK Microcap Trust’s strategy was set up in anticipation of this potential. If the economic and market patterns are fundamentally changing, then the Trust’s strategy is well-set to deliver a long period of premium returns.
Gervais Williams and Martin Turner
5 July 2021