Award-winning fund manager and head of equities at Premier Miton Gervais Williams talks to us about cheap small caps, Neil Woodford’s empire collapse, valuations, liquidity and investing tactics for 2020.
Lee Wild, head of equity strategy at interactive investor:
Small caps in 2020, it's the big question. Lots of big investors are liking UK small caps at the moment, they're undervalued, primed to benefit from the resolution of Brexit, whenever that might be.
So, in your view, will 2020 be the year of the UK small cap?
Gervais Williams, fund manager and head of equities at Premier Miton:
I think so, they have been oversold, as you know, there's a lot of anxiety about Brexit at the moment, which has held up investment over the last 12 months in particular, some of the share prices have actually been falling whilst the market has been rising.
Of course, the area which I think is probably the most affected over this year, has been actually the micro-cap area. I think they're even cheaper and I’m rather hoping that they have an even stronger recovery, albeit perhaps after a bit of time lag.
A lot's been happening in the world of small caps in 2019, the event that continues to resonate is the collapse of Neil Woodford's fund empire. What impact on AIM and small caps have you seen? Any fallout that's affected the Miton funds?
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I mean the interesting thing about the Woodford fund, and I think one of the causes of anxiety, was actually the private companies held in his OEIC. And I think the size of those ultimately became an issue. Specifically, a lot of the holdings he put into his fund also were quite heavily loss making, needing more funding.
In both cases, we tend to hold only quoted companies, but most particularly, have tried to invest in companies where they've already had the last funding. They're slightly more mature, they're into the cash payback phase.
So, we haven't had any direct effect from the Woodford fund. Of course, it has affected anxiety about the sector overall, and we have had a lot of communication with our clients to try and reassure them about how we do things differently.
So, you don't have any sort of wider concerns about the impact of the collapse of that fund and AIM?
Well, I think any time when clients don't do well is of interest to the whole industry. And there's always a big issue about whether clients actually do get a good outcome. We're very focused on that. I think we'd like to think that this is not the main pattern, this is just an individual case. And, if we can deliver plentiful returns to our clients in the long-term, then we believe that actually this issue will be transitory.
The investment industry is becoming more tightly regulated and, in most cases, so it should be. Is there an area of the industry that you think requires attention, or perhaps where the regulators have gone too far, or perhaps even got it wrong? Do you expect any sort of regulatory involvement through 2020?
I think what's been interesting about the last few years is just how much the regulatory bill has been there, there's been a lot of changes. A lot of new initiatives coming on top of other initiatives. So, I think it's been a very significant burden for us all to continue to improve.
That said, as you say, we need to get better. We absolutely need to deliver for clients, and if the regulator can help us do that, then we're delighted. I think the bigger issue is probably going to be the political issue. I think, politically, fund management is becoming a lot more central to the political process, they're interested in how we engage with the companies, particularly on the environmental concerns.
And I think those issues are only going to get more prominent going forward.
And as you say, there's clearly more to be done, and do you see - you talk about a regulatory burden, but Miton specifically, do you think the fund industry more widely is prepared?
Obviously, there's cost involved, and when there's cost involved, it just means that companies can't invest in other things. And, of course, it does ultimately mean that fees, you know ultimately the customers pay for this.
But if it's delivering good outcomes, then we must be thrilled. And the UK does lead the world in terms of regulatory standards. In terms of governance in particular, the UK is one of the leading investment markets in the world.
So, we're pretty upbeat really about the ability of us to do things well and to deliver a good outcome for our clients.
And moving onto liquidity. It’s always been high up the list of criteria for you as a fund manager, but it's taken an even greater importance in recent months. Has it affected your investment behaviour at all?
Interestingly, I'm going to say no actually, which may surprise people. But we've always been horribly interested in liquidity. We invest not just in big companies, or even medium sized companies, we invest in small and some microcap companies. So, liquidity has always been a big issue for us.
For that reason, we've always had quite long portfolios, often extending over 100 stocks, so that gives us more individual stocks to hold, more opportunities to sell, more opportunities to raise liquidity if we need it.
Specifically, it dilutes stock specific risk, which obviously can be more significant this end of the market. And most particularly, we actually like to be involved in companies where, hopefully, we can make a difference in terms of actually affecting the outcome.
New capital from our clients will often lead to a substantial outcome, if it comes right. And, as those companies get bigger, of course, other investors start to look at them, and you get a virtual spiral, and that drives up not just the share price, but also the liquidity.
And could you explain your liquidity monitoring process. Even with some of the much larger cap funds, there have been concerns about liquidity, and concentrated portfolios. How do you keep on top of that, and make sure that it doesn't become a problem for you?
What we tend to invest in is companies with strong balance sheets as a starter for 10. This means, ultimately, they don't need new liquidity from us. When you're competing with a company to actually sell shares, if you need to sell them, if the company needs to sell them and you need to sell them, then you get into liquidity problems.
It's actually a cornerstone, we like to have companies with very strong balance sheets. Thereafter, if we get companies who are actually getting into the cash payback, as that cash payback starts to grow, they can pay dividends. As they grow their dividends, again it's another pit prop, holding up share prices, bringing in more investors for other reasons.
So, we tend to invest quite widely, across quite a wide range of sectors, to diversify risk. We look for companies which are hopefully beyond the capital raising process, into the cash payback period.
And, most particularly, when we get them wrong, of course, we sell them. It sometimes takes a little while, but actually since we've got such a wide ranging portfolio, we’ve got many other things which actually are doing pretty well, hopefully at the same time, which means we’ve always got plenty of liquidity for clients if they need to redeem their units.
The UK fell in the popularity stakes through 2019, and small caps didn’t have the best year perhaps. Are you concerned about possible outflows, not just from Miton funds, but across the industry? And then do you expect that trend to reverse in 2020?
I mean I think we have seen quite significant outflows out of the UK in the last three years since the Brexit referendum. And, generally, people have been a bit anxious about what kind of Brexit resolution we come to. That uncertainty has definitely been a significant feature in terms of capital allocation. Many international investors have moved to an underweight position.
Even many domestic investors have actually moved to restrict the amount of money going into the UK for the time being. So, both of those factors have actually led, not so much to the UK not just performing well, but actually in valuation terms, moving below many of the other equivalent funds, countries around the world.
On that basis, we think the UK is overdue a period of performance catch-up. And we expect that as that comes through then we’ll start to see not just mainstream companies, but many small companies which are more domestically based actually enjoying the best of the uplift.
Of course we’ve heard from some of the Bulge Bracket banks, and from other areas of the market that the UK is the standout value trade at the moment, but are you confident that this shift, that there becomes fewer places for investors to put their money into a true value play, that becomes the strategy for 2020? Do you think these guys have got it right?
Yes, I mean obviously we look forward to getting more excited about the UK, more allocation of the UK, but most particularly, even if we don’t get more allocation to the UK, what we're already seeing is that companies themselves are taking over other companies.
We've seen a surge of takeovers coming in, not so much the very largest companies, but some of the mids and small caps stocks. So, in our portfolios across both our small cap and our multi cap income fund, for example, we've seen 17 takeovers since the end of September last year (2018).
So, it just shows how many takeovers we’ve seen, how much uplift there is, and that hopefully will continue to generate returns even if we don't get a major allocation into the UK.
Out of all of the stocks in your portfolio, there will be some that you have a greater conviction about than others. If I asked you to name companies that you had the highest, greatest conviction about for 2020, which would they be?
I mean one of the ones I might mention actually is Kenmare Resources (LSE:KMR). Kenmare is a company which is involved in producing mineral sands, particularly ilmenite. Ilmenite is the whiteness which is used in paints and paper and a lot of the major products around the world.
It is one of the larger mines in the world, it's been going for many years, but most particularly, it's entered the cash payback phase. Its debt is coming down now, and so we're in the period now when it’s generating profits. It's on a low PE, below six times. It's a reasonable sized company, about £240 million.
But most particularly, as the profits generate more cash, we're going to see hopefully a dividend. They’ve started paying a dividend for the first time. We expect that dividend to grow very nicely over the next three years.
In terms of sectors or investment themes that you expect to deliver outperformance in 2020, are there any that the viewers should be following as we move into the new year?
I think generally the markets may become more choppy, I think they have started being a bit more choppy, if you remember at the end of 2018, markets were falling very hard. Then they recovered very much this year. Then we've got worries about Brexit.
All of this is leading to quite choppy markets, I think it will be a mistake to really look at sectors. I think what we've got to find is individual stocks which operate in all sorts of miscellaneous sectors.
So, get away from just worrying about financials, or whether you're got enough oils. Try and get in amongst it on individual stocks. I think bottom up stock selection is the way forward. Strong balance sheets, resilient companies, and most particularly, those which are generating a substantial sustained cashflow, which can ultimately come out, not just in cash generation within the business. But ultimately in our view in dividends.
Dividends are the pit props we think, to long-term investing, and if we can find companies which can generate sustained dividend growth, then we believe they will actually be the companies which perform, even in more unsettled markets.
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Is it getting tougher to find secure income, decent dividend payers with a history of growing the pay-out as well? Is it getting more difficult or are you finding it as easy as ever?
Well, it’s very interesting actually, we’re getting a real kind of bifurcation in the market. There's been a real momentum and sort of growth trend which has meant the best performance is often by some of the higher growth stocks, which aren't generating much income.
And then many of the more ordinary kind of everyday companies, regular companies, generating a good amount of cash, and hopefully growing their dividends, have if anything, fallen in value.
And that's very much true out of the major top 350 stocks in the small caps and the micro caps. So, if anything, we’re still finding plentiful opportunities at the bottom end of the market. Income generating stocks, companies which we believe do actually have good prospects, even quite resilient prospects in an uncertain world.
The whole point about small companies is they can grow when the world's not growing. They don't find it easy, but they can do that sometimes. And that's where we’re getting the opportunities. We don't expect world growth to be that buoyant in the next couple of years. We think many small companies with income, or potential income are to be the best performers going forward.
So, there's lots of debate around strategy at the moment, there's growth versus value, I mean that's really the, I guess, the major one that we hear most about. I mean we all want to buy stocks at the right price, no one wants to buy expensive stocks if they don't have to.
But how do you feel about valuations in the small cap space? Do you wince at some of the ratings that some of these smaller companies are trading on at the moment, or do you come from the position that you get what you pay for, and you would rather pay for quality?
Yes, I mean I think the whole point is we do want companies which are going to generate a premium return. It’s getting a little harder because we’ve been in a 10-year bull market. We had a little bit of a wobble in 2011, but generally been rising since 2008.
So many companies are standing on relatively demanding valuations. Going forward, we think the world's going to be less easy. There will be setbacks. We think events, geopolitical events could set things back along the way as well. So, you want companies which aren't just going to generate a return and you've got companies which actually hopefully can minimise risk.
We think downside risk is almost as important as upside opportunity. So again, we come back to the importance of strong balance sheets, we come back to the importance of a defendable margin, even at a time when perhaps other companies come into your industry. Particularly driving quality service, outstanding customer service, is tremendously important.
The ability to invest in your business, specifically having external capital as a PLC, means that when capital is scarce, perhaps at a time of a more difficult market, you can pick up assets from the receiver, put some cash to work, and get very rapid paybacks on some of those assets.
We think these are things which are going to be important. Interestingly, when you go back to the 1970s, we had recessions and weak sterling and unsettled governments, and all the things which we've been running through more recently, actually small caps were the best performing sector.
It's very interesting that they've had very little of that in the last two or three years. We think that that factor itself will be very attractive, always assuming that you can minimise risk and pick a range of stocks with a risk-reward ratio in a group which are outstanding.
[Video filmed on 4 December 2019]
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