Investing in tomorrow's big businesses

21 July, 2021

We examine the case for micro-cap investing, or investing in the UK’s smallest businesses, and explore how Downing Strategic Micro-Cap applies private equity-style investing to this area of the market…

Sponsored by Kepler Trust Intelligence

In the hunt for growth, it has long been understood that smaller companies outperform their larger-cap peers over the long term. Smaller-cap companies can afford to be nimbler in the face of evolving demand and often fulfil very specific needs within their local, regional or wider economies.

Yet, for private investors, the very smallest UK companies, with the greatest potential for growth, are often so sparsely covered by analysts that it creates one of the key opportunities to find companies that are priced incorrectly, relative to their true value and potential. These companies are also rarely targets for the kinds of professional investors who will roll their sleeves up and help realise this value.

Tapping into the talent pool

Downing Strategic Micro-Cap (DSM) is a small trust that gives investors the opportunity to tap into just this kind of expertise. As a business, Downing has a long track record of investing in the smallest companies, including in private equity and venture capital. This gives DSM’s management team the skills and experience to assess the operations of smaller companies where disclosures and practices may not be as clear as in larger-cap companies.

The team behind DSM is led by Judith Mackenzie, who personally has over two-and-a-half decades of experience in investing in very small companies. Together, they target companies that they believe are fundamentally mispriced thanks to a problem or issue (real or misunderstood by the market), but which the team believe will be surmounted over time.

A crucial aspect of their process is to work with managers and boards of the underlying companies to help them make improvements. However, they are not afraid to force change where required. This active management style is crucial to producing the team’s targeted 15% over five years.

The bedrock of the British economy

One of the defining characteristics of DSM’s investee companies is that they tend to produce clear, definable products, which have already been brought to market with some degree of success.

A significant stake for the trust has been in Real Good Food. The company is best known for owning Renshaw, the manufacturer of ‘ready-to-roll’ sugar paste icing. However, it also owned Brighter Foods, which manufactures health food bars on an outsourced basis for brands. Earlier this year, Brighter Foods was sold to The Hut Group for £43m. DSM’s stake in Real Good Food was structured with loan notes and equity, and the sale of Brighter Foods allowed the repayment of a significant proportion of its loan notes, at a profit to DSM, representing a successful demonstration of the company’s private equity-style investment process. DSM, through its board seat and the structure of its shareholding, helped turnaround Renshaw and grow Brighter Foods. Investment in innovation has been especially key for Renshaw, resulting in the development of a frosting that has performed better in testing than the market leader, which should allow it to counter the falling demand for sugar paste icing.

Another significant stake for the trust is in FireAngel. FireAngel manufactures state-of-the-art fire and carbon monoxide detectors. The detectors, which are both battery and mains-powered to ensure resilience, are interlinked, which means that an alarm can be heard from every device, regardless of where a fire originates. This is especially important in blocks of flats, for example, with the aftermath of the Grenfell disaster demonstrating the importance of having the most up-to-date fire safety equipment fitted. The company has had particular interest from social housing providers, such as Ealing Council in London, which signed a contract to install more than 122,000 FireAngel devices across its properties.

Investing in the UK’s future trends

For investors considering differentiated growth opportunities, the micro-cap end of the market could be an interesting place to look. By being active owners of their underlying companies, the team behind Downing Strategic Micro-Cap seek to embed healthy, organic growth and good governance within those businesses. This model, which is unique in the listed micro-cap space, offers retail investors an experienced lens into businesses that they would not normally contemplate. The trust is currently trading on a discount of around 13% to NAV.

Downing Strategic MicroCap is a client of Kepler Trust Intelligence. Material produced by Kepler Trust Intelligence should be considered as factual information only and not an indication as to the desirability or appropriateness of investing in the security discussed. Kepler Partners LLP is a limited liability partnership registered in England and Wales at 9/10 Savile Row, London W1S 3PF with registered number OC334771. Full terms and conditions can be found on www.trustintelligence.co.uk/investor