River & Mercantile UK Micro Cap (RMMC) aims to achieve long-term capital growth from investment in a diversified portfolio of UK micro-cap companies, typically comprising those with a market cap of less than £100 million at the time of purchase.
The company launched in December 2014, with George Ensor having taken over as manager from Philip Rodrigs in 2018. George looks to utilise an active, bottom-up strategy looking to add real value in the micro-cap end of the market via in-depth analysis where coverage is sparse. Like all managers at River & Mercantile, George follows the group’s PVT (Potential, Valuation, Timing) investment approach (see portfolio section).
As of the end of June 2019 the portfolio is relatively concentrated, with only 43 holdings, but diversified by size and sector. Only financials have a weighting greater than 20%, and even the largest sector overweights, oil & gas and health care are relatively low at +6.5% and +5.4% respectively.
Performance has been varied since George took over the portfolio in a difficult period for UK small cap managers. Initially, performance was strong and for much of 2018 the trust outperformed the benchmark and peers alike. However the trust saw its returns hit hard in Q4, ruining what might have otherwise been a strong start for the new manager. Since then, to 28 August 2019, the trust has returned 6.6% marginally underperforming the benchmark (6.9%) and trailing the AIC peer group (9.5%).
As with most UK focused trusts, the past few years have seen the discount widen dramatically – although in this case, exacerbated by the change in manager in early 2018. Over the past two years the trust has reached a premium of close to 17%, and a discount of over 20%. Currently the trust is trading at a discount of around 20%, considerably wider than the sector average of 9.2%.
There are plenty of things to like about River & Mercantile UK Micro Cap. Firstly, the manager isn’t afraid to have conviction behind his approach, illustrated by the low number of holdings in the portfolio and the fact George often invests in companies that could be considered out of favour. Nevertheless, the portfolio is well diversified across industries and this is reflected in the low beta of the portfolio and low volatility in comparison to peers.
George has come to the helm of the portfolio during a tricky time for managers, especially those within the UK small cap space. The trust was hit particularly hard in Q4 due to style exposure and some stock selection issues. Since then, returns have improved; although still lagging the peers. However, this might have been over exaggerated in the discount and having gone from trading on a very hefty premium only a year and a half ago, the trust is now trading a discount of close to 20%, offering a clear opportunity for investors. Should we see some of the pessimism surrounding the UK subside, the discount could well narrow.
|Strong performance since inception
||New manager has yet to outperform the benchmark and peers
|Extremely wide discount relative to peers and history||Pessimism continues to surround the UK
|Specialist mandate that suits the investment trust structure||Relatively expensive OCF|
River & Mercantile UK Micro Cap (RMMC) aims to achieve long-term capital growth from investment in a diversified portfolio of UK micro-cap companies, typically comprising companies with a market cap of less than £100m at the time of purchase. The manager, George Ensor, utilises an active, bottom-up strategy looking to add real value in the micro-cap end of the market via in-depth analysis where coverage is sparse.
George’s strategy is built around benefitting from the systematic biases and mistakes of the market. The portfolio is predominantly made up of growth and quality companies, where the consensus either underestimates sustainable growth (growth) or overestimates how quickly the returns to successful companies will fade (quality). As can be seen below, these two areas make up close to 80% of the portfolio, however recovery situations and asset backed companies also feature, albeit less heavily, where the consensus underestimates mean reversion (recovery), or the consensus focuses on short term earnings (asset backed).
Quantitative screening and fundamental analysis are at the heart of the approach, along with River & Mercantile’s renowned PVT (Potential, Valuation, Timing) criteria. In order to qualify for investment, each company needs to illustrate three characteristics:
- Potential - A catalyst or investment dynamic that will create value for shareholders
- Valuation - A discount between the current share price and what the manager deems to be the company's medium-term worth
- Timing - An attractive entry or exit point to maximise returns for investors
Typically RMMC will hold between 30 and 50 companies at any one time, and as of the end of June the portfolio had 43 holdings. The top ten holdings as of the end of Q2 can be seen below.
top ten holdings
|Litigation Capital Management
|Diversified Gas & Oil
Source: River & Mercantile
Despite having a relatively concentrated portfolio, the holdings are well diversified. As can be seen below, across the market cap spectrum there is an even split among size of the companies, helping to differentiate the revenues among companies depending on the stage of their life cycle.
Market capital allocation
The sector exposure of the companies is also well diversified. Financials is the only sector to have a weighting greater than 20% (22.8%), however the largest sector overweights come from oil & gas (+6.5%) and health care (+5.4%). At the other end of the spectrum, the portfolio has very little exposure to consumer services and consumer goods (-9.7% and -5.7% relative to the benchmark, respectively).
The trust does not intend to employ gearing in normal market conditions, and over the past five years no facility has been used. With this said, if the manager and board believe it is opportune to do so, then RMMC may employ gearing up to a maximum of 20% of NAV.
As can be seen below the trust has been an incredibly strong performer since launching at the end of 2014, delivering NAV total returns of 95.2%, considerably greater than the benchmark Numis SC Plus AIM ex Invt Cos Index (34.7%) and the AIC peer group (51.6%). Over this period the trust has delivered an annualised alpha of 11.4%, at a standard deviation of just 10.6%. In comparison, the FTSE All Share and MSCI World have standard deviations of 19.4% and 20%.
The new manager, George Ensor, took over in February 2018 and since then the performance has been more varied. Initially, performance was strong and as can be seen below, for much of 2018 the trust outperformed the benchmark and peers alike. However the trust saw its returns hit hard in Q4, where the NAV of the trust fell 21.7% (according to River & Mercantile), lagging the benchmark by 7.1%. This poor performance was attributed to a mix of style exposure and poor stock selection. RMMC has long been heavily exposed to growth companies, and although the manager had been rotating out of the more expensive of these, exposure to them did hurt performance. At a stock level, Boku and Taptica both performed particularly poorly. Boku, a mobile payments platform, was down 59% in the quarter, after the market reacted extremely negatively to a venture capital sell down and acquisition of a rival technology company with leadership in mobile identity. In Taptica’s case, the resignation of the CEO who was found liable for breaches of a merger agreement for the prior sale of a separate business, saw the shares down 57% over the fourth quarter.
Since then, performance has made an improvement in absolute terms. As of 28 August 2019, the trust has generated NAV returns of 6.6% this year, in line with the benchmark (6.9%) and only marginally trailing the AIC peer group (9.5%). The strongest performances have come from Tekmar Group, Allergy Therapeutics and Keystone Law.
The company does not pay a dividend to investors and instead uses a redemption mechanism for capital returns. The board intends to use the redemption mechanism to keep the total net assets to around £100m, to continue to allow them to invest in micro-caps. Over the financial year ending September 2018, £27m was returned to shareholders through the redemption mechanism. This was after £15m was returned in December 2017 and £12m in July 2018.
Following an investigation by the FCA into collusion and sharing information on the pricing of initial public offerings, ex-manager Philip Rodrigs left River & Mercantile Asset Management. As such, on 7 February 2018 George Ensor was appointed to take over at the helm of the portfolio.
George had assisted Philip on the Trust as an analyst since launch in 2014 and joined the business four years prior to that from Smith & Williamson. Like all managers at River & Mercantile, George follows the group’s PVT (Potential, Valuation, Timing) investment approach.
The past five years have seen some significant fluctuations in the River & Mercantile UK Micro Cap discount. On average over this period, the trust has traded at a discount of 3.9%, however the range has been between a discount of 21.1% and a premium of 16.9%.
Much of this variation has come over the past few years, due to the change of manager and the uncertainty surrounding the UK and its political situation, which has had a dramatic impact on sentiment towards the entire small cap space. This has meant the discount has continued to widen throughout 2019 and currently sits at 20%. This is considerably wider than the rest of the AIC sector, where the weighted average is 9.6%.
River & Mercantile has one of the higher charges in the 15-strong sector. Currently, the OCF is 1.25%, relative to the sector weighted average of 0.79%. Of this, the management fee equates to 0.75% of net assets. Alongside the fee, the company charge a performance fee of 10% of NAV total return outperformance relative to the benchmark.
The KID RIY for the trust is 0.92%, the second lowest in the sector where the weighted average is 1.45%. With this said, the methodologies for working out the KID RIY can vary among companies.