CF Miton UK Smaller Companies Fund

Q2
2017
Investment report
For investment professionals only
CF Miton UK Smaller Companies Fund
Summary
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UK smaller companies led the market rise over Q2.
The fund appreciated by 2.1%.
There have been an increasing number of takeovers amongst small and micro caps.
There are some indications that bank lending is now accelerating and this could drive further growth in the UK economy and ongoing outperformance of the smallest quoted stocks.
Market review
The headwinds within the UK economy became more apparent, with a slowing of retail demand, an
unexpected General Election that led to a hung parliament, and the ongoing Brexit negotiations during
the quarter. And yet in spite of this, the best performing part of the market has remained that of smaller
companies in spite of its perceived domestic bias. However, with world growth remaining modest, the
best performing stocks within the AIM market have typically been growth stocks. In a similar way to the
US, where the Facebook, Amazon, Netflix and Google led the rise, many of the fastest growing AIM
stocks have moved on to demanding valuations. Over the quarter, the FTSE AIM All Share Index rose
4.3%, with FTSE Small Cap (excluding Investment Trusts) Index rose 2.9%.
This extends the trend of the first quarter, with the FTSE AIM All Share Index now up 15.2% over the
half year compared with the FTSE Small Cap (excluding Investment Trusts) Index up 8.8%.
Performance
The Fund rose 2.1% over the quarter, which compares with the FTSE AIM All Share Index that was up
4.3%, and with FTSE Smaller Companies (excluding Investment Trusts) Index that rose 2.9%.
The announcement of a General Election led to an immediate rise in the Sterling exchange rate. Though
the result led to greater uncertainty, it is noteworthy that the currency did not fall back, at least not
immediately. Generally, multinational companies tend to underperform when Sterling is strengthening,
as the value of overseas earnings declines. Therefore, the strength of Sterling did favour smaller
companies given that they frequently have a greater bias towards the domestic economy.
However, this has to been seen in the context of the wider moves within the market. The recovery
of commodity prices early in 2016 tended to favour the mainstream oil and mining companies at
that time. With a sharp devaluation of sterling after Brexit, these multinational groups, and others
enjoyed a further period of outperformance. However, over the twelve months to the end of June 2017,
smaller company stocks have been in a period of performance catch up, driven by growing investor
enthusiasm for the fastest growth stocks. But aside of this, there has been ongoing support for plcs
that are generating good and growing dividend income.
Therefore, the best performing index over the last twelve months has been the FTSE AIM All Share
Index with a rise of 38.6%, given the very strong performance of many of the largest AIM listed
growth stocks. However, alongside that the FTSE Small Cap (excluding Investment Trust) Index also
appreciated 28.4%. Both of these are well above the FTSE All Share Index, which being dominated by
the largest stocks actually underperformed returning 18.1%.
Page 1
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Q2
2017
Investment report
For investment professionals only
CF Miton UK Smaller Companies Fund
The CF Miton UK Smaller Companies Fund has appreciated by 27.0% in that twelve-month period, as
the ongoing focus on stocks generating good and growing income delivered returns.
Performance attribution
The fund held a position in Utilitywise for its recovery potential. However, the share price fell by
55.8% during the quarter as it announced that they would need to repay £7.6m to one of its’ supplier
utilities given under-consumption versus contracts it has broked to industry users. Mercantile Ports
and Logistics also detracted from performance, since its share price fell back 46.2%. Again this stock
has plenty of recovery potential as it is due to bring its new port onstream over the next twelve months
in an area where there is a chronic shortage of capacity. The fund has held Hurricane Energy, for a
little over a year during which time the stock had doubled as it proved up a very larger field in the North
Sea. However, the stock fell back on rumours of a fund raising to bring it into full production, which
has now been completed. Clearly all of these stocks have reduced the fund return, but in these three
cases we believe the businesses remain well financed with good reasons to expect the share prices
to recover back to their previous levels and beyond.
Some the strongest performers in previous quarters have continued to deliver good returns once
again. For example, IG Index is now the largest holding in the fund, and though it only appreciated a
further 14.2% in the quarter, the value it added was still similar to the amount that Hurricane detracted.
IQE was up another 37.7% , and Burford Capital rose a further 17.7%. Lastly Kromek, also rose 19.6%
during the quarter and was another notable performer.
Portfolio activity
Following the takeover of NetDimensions at the end of the last quarter and Shawbrook Group both of
these companies have been sold. In addition, substantial profits have been taken on the holdings in
Burford Capital and Fulcrum Utilities though they still remain holdings in the portfolio.
There have been some attractively valued IPO’s coming to market, with Ethernity Networks being the
most exciting in our view. This company helps address the bottleneck in data handling at household
routers caused by additional links from security detectors, internal cameras and heating control
systems. The business is already profitable, and is being contracted by several major US companies
who want to use their systems to help address the issue. In addition, a new holding was taken in Eddie
Stobart Logistics at issue, since the company has further increased its efficiency through improving
the use of its trailers on the backhaul part of their journeys. Elsewhere the fund has become fully
weighted in Augean; a company with specially prepared pits to take low-level nuclear waste as a
number of facilities are demolished. In addition, the holding in Safecharge has also been built up to a
full weighting. Safecharge offers online retailers the platform so they can collect credit card payments
within their websites. The company is expanding well, and also has a very strong balance sheet with
$115m of surplus capital.
Overall, the fund continues to the largest weightings in IT holdings that account for 29% of the fund at
the end of the quarter – including IQE at 2.7%, Cerillion and Kromek at 2.6% and 2.1% respectively.
Industrials remains a substantial part of the fund at 17%, now including Augean at 2.0% and WYG
at 1.7%. And though the fund has 16% in Consumer Discretionary holdings, these are not typically
dependent on UK consumer spend. The largest is IG Design at 3.7%, selling wrapping paper and
Page 2
Broker Desk 020 3714 1525
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Q2
2017
Investment report
For investment professionals only
CF Miton UK Smaller Companies Fund
cards around the world, Coats at 1.9% the leading worldwide thread business, and Autins Group, at
1.5% which is a UK manufacturer of insulation products for the automotive industry.
Outlook
Generally, mainstream UK equities have continued to add further return in spite of the more challenging
economic headwinds in the UK, and the uncertainty regarding a minority government. Meanwhile
smaller stocks continue to outperform, especially the rapid growth stocks.
The global economic trend may be slightly better recently, but if anything the geo-political outlook
has become more worrying. This is unhelpful since corporates have been holding back on capex,
and therefore productivity has largely failed to improve for the last ten years or so. This has been
feeding through to less tax take than governments would like, a marked reduction in dividend cover
because companies have grown their dividends faster than their earnings, and very modest pay rises
for many. This latter point is now coming through in terms of a profound change in the attitudes of
the electorate. Most elections are now marked by renewed willingness to vote for politicians who are
suggesting a change away from the previous economic policies.
All this implies that the previous status quo may be coming to an end, with different economic and
market trends going forward. This is a time when fund managers will need to be extra attentive to
downside risk, as well as identifying those that might be well positioned to benefit from the new
trends.
In this context it is interesting to note that the number of fund raisings by smaller quoted companies
has been very buoyant. Whilst there are real challenges ahead such as Brexit, there do seem to
be more than enough smaller capex opportunities for many individual smaller companies to raise
additional capital. Some are too speculative for us, and others are likely to generate a cash payback
extending too far out. However, many others are building on their existing operations with scope to
generate real growth in their cashflow over the next three years. As this generates a new stream
of cashflow we believe it will drive up their valuations, often from a sub-normal position. The CF
Miton UK Smaller Companies Fund has a wider investment universe than many others given the
willingness to invest in the smallest quoted companies. Therefore we are upbeat about the prospect
for generating an attractive return going forward.
Alongside this, the holdings in a fund like this tend to operate in different economic sectors compared
to the mainstream indices, and therefore the pattern of the returns from the fund is often less correlated
with the movement of the mainstream indices. We believe at a time of increasing challenge on asset
performance generally, the less correlated returns of the CF Miton UK Smaller Companies Fund will
be of particular advantage to investors holding funds with significant weightings in the mainstream
stocks.
Page 3
Broker Desk 020 3714 1525
www.mitongroup.com
[email protected]
Q2
2017
Investment report
For investment professionals only
CF Miton UK Smaller Companies Fund
Important Information
The value of stockmarket investments will fluctuate, which will cause fund prices to fall as well as rise and investors may not
get back the original amount invested. For Investment Professionals only. Not for onward distribution. No other persons
should rely on any information contained in this document.
Source of performance data: FE as at 30/06/2017, Index performance - bid to bid basis, Sterling Class B Accumulation
shares, net income reinvested, mid to mid basis. Source for all other data: Miton as at 30/06/2017.
RSMR Fund Rating as at 30/06/2017.
The views expressed are those of the fund manager at the time of writing and are subject to change without notice. They
are not necessarily the views of Miton and do not constitute investment advice.
Miton has used all reasonable efforts to ensure the accuracy of the information contained in the communication, however some information and statistical data has been obtained from external sources. Whilst Miton believes these sources to be reliable, Miton cannot guarantee the reliability, completeness or accuracy of the content or provide a warrantee.
The Prospectus, KIID and application forms are available in English from the Authorised Corporate Director of the fund,
Capita Financial Managers, at www.capitafinancial.com; or from Miton, the Investment Manager of the fund, at www.
mitongroup.com.
This financial promotion is issued by Miton, a trading name of Miton Asset Management Limited the Investment Manager
of the Fund which is authorised and regulated by the Financial Conduct Authority and is registered in England No.
1949322 with its registered office at 6th Floor, Paternoster House, 65 St Paul’s Churchyard, London, EC4M 8AB.
MFP17/317.
Page 4
Broker Desk 020 3714 1525
www.mitongroup.com
[email protected]