Contrary to popular belief, investing in the alternative investment market (AIM) can expose you to international as well as domestic end-markets, and a wide variety of niche sector specialisms.
Amid election and Brexit uncertainty some investors have been put-off small-caps*, instead opting for the perceived safety of larger internationally exposed companies in the FTSE100. Caution is fair. The necessary Brexit shock absorber of a weakened pound has served to import inflation and threaten domestic spending in the short-term; and clearly business uncertainty surrounds negotiations with the EU and what this will mean for the UK economy.
Aware of the uncertainties, fund managers James Henderson and Colin Hughes of Henderson Opportunities Trust – a multi-cap portfolio that aims for out-and-out capital growth – have been seeking opportunities across the wide range of diverse business areas found in the small-cap space.
Around 50% of the portfolio is in AIM, otherwise known as London’s junior market. Here firms are small - tending to be no bigger than around £2bn.
Many of the UK’s youngest and brightest star companies start here due to its less onerous rules on listing. It comes with risks of course: lighter touch regulation; greater share price volatility; poor liquidity (the ease in which you can buy and sell shares in larger amounts); concentrated revenues on fewer product lines; concentrated end-markets for sale.
But if you’re comfortable with taking a bit more risk, capital returns on AIM can be significantly greater than that of the larger FTSE100 listed stocks.
Henderson and Hughes have many years’ experience picking AIM stocks and point to the fact that, if firms put their noses to the grindstone, it’s much easier for a small-cap to transform revenues of £10m into £100m, then it is for a larger firm to turn £1bn into £10bn. It is this potentially strong growth of earnings that translates into stellar share price returns.
The sheer diversity of it!
Hughes points to AIM’s wide variety of sector specialisms. It drives profitability through their strong dominance of niche markets, often creating growth that is structural – where revenues come in regardless of the health of the wider economy. It contrasts the FTSE100 where businesses operate in more commoditised product or customer-sets such as in banking or oil & gas, and are grouped in fewer sectors.
He adds that the multi-cap approach is a key advantage of the Trust because volatility can be dampened by larger-cap positions and diversity added to with small-caps, extending the revenue reach of the portfolio into a multitude of weird and wonderful marketplaces.
The global exposure of AIM companies is also perhaps surprising to some, who traditionally view the smaller company sector as domestically focused. Indeed Henderson and Hughes have constructed a blended portfolio where the underlying companies’ revenues are broadly split 50/50 between international and domestic markets.
RWS – Lost in translations
RWS specialises in translation services for patenting and life sciences, two very niche areas. The former is its bread and butter as the longest running segment and biggest slice of its revenues, operating in 130 countries across the world. Life Sciences became material more recently in 2015 following the acquisition of Corporate Translation. It is a very separate but equally skilled area.
The traditional business model is under pressure as creeping technology disruption creates an increasingly commoditised market for straightforward translations. RWS sidesteps these risks due to the fact its work requires much more specialist technical knowledge alongside the linguistics. Even the most advanced algorithms are unable to deal with the complexities, allowing RWS to command higher prices and strong margins.
Blue Prism – Robots, of a kind
Commentators laud the creeping disruption created by a world of increasingly intelligent robots. The Terminator it may not be, but jobs aplenty are up for automation. Analysts put half of all US jobs at risk.
Blue Prism operates in this space, in an area called Robotic Process Automation (RPA). This involves software robots whose job it is to take over some repetitive back-office task performed by humans and recreate it more accurately, cheaply and quickly.
The company differentiates itself through the crossovers their RPA software has with artificial intelligence (AI). AI is a broad term but largely based on ‘machine learning’ concepts – the idea robots can use the vast quantities of data that we or other processes create, recognise patterns they’re not programmed to find and then learn from them and adapt software processes for the future. Blue Prism’s robotics are intelligent but only ‘learn’ in a supervised fashion – you may not want processes changed outside of their programmed confines, particularly where regulatory or technical specifications are quintessential to the task at hand.
The other important point here is that RPA processes can be retrofitted to incumbent systems without the need for complex integration – ideal for legacy systems or where large scale M&A has taken place.
Its solutions have been generating high returns for projects, creating ‘sticky’ customers who return to commission further projects as they deliver strong results to their Boards. Their clients are spread across a multitude of industries and locations, including Fidelity, Bank of Ireland, IBM, Accenture and Deloitte.
Safestyle – Framing the future
Safestyle operates in a domestically focused niche sector, and is a market leader. It’s a pure investment play in an area called RMI (repair, maintenance and improvement) in the residential housing sector. Here they replace old style windows with new plastic PVCu ones. It’s a strong market as the UK has some of the oldest houses in the western world and over the past decade little has been invested in maintenance.
It’s a cash generative business helped by its low-cost asset base. Safetstyle has risen to become market leader amid high margins from economies of scale and strong pricing power. But its dominance is focused in the North; its strategy to ramp-up its operations in the south to gain further market share forms the backbone of the investment case. The niche dominance it holds is very attractive in an RMI cycle that is swinging to the positive.
Small is mighty
The business interests of small-caps are wide and varied, particularly those listed on AIM. Risks come with investing in smaller companies but the experienced fund managers of Henderson Opportunities Trust’s construct the portfolio to best manage these risks and diversify the revenue’s geographic and sector exposure. They believe this blend should enable the fund to deliver the portfolio’s aim of strong capital returns over the long-term.
* Small-caps – Small capitalisation refers to the total market value of a company’s public shares; or in other words, the size of the business. In the UK this means those of around £200m to £2bn in size.