I’m sure you’ve all come across the reality TV programme Dragons’ Den in the past 17 years. For the few that haven’t, it sees entrepreneurs pitch their business ideas to a panel of venture capitalists in the hope of securing investment to help their businesses grow.
My latest bout of channel-surfing resulted in me finding a “best moments” compilation for the show last week, highlighting the greatest ideas to come to the den. These included Levi Roots’s Reggae Reggae Sauce, a business which is now worth some £30m; and Magic Whiteboard, a portable whiteboard roll that became such a success that a roll currently resides on the walls of my own home.
However, we must remember 60 per cent of start-up businesses fail in the first three years – so planning is everything. Therefore, I really enjoy watching the Dragons pick apart a business – this can range from the exclusivity behind an invention, the numbers projected and any previously unseen product pitfalls. But if they are confident they get the right answers, then early backing can garner huge profits.
It reminded me of this week’s fund, which I can consider to be the ultimate opportunist. The Liontrust UK Micro Cap fund has a simple yet successful remit.
The majority of the fund will be invested in businesses with a market capitalisation of less than £150m. It is a finite window, as companies do move out of the portfolio once they grow beyond a certain point – but it is where the team can really take advantage of early-stage growth in an under-researched area.
What helps this fund stand out from its peers is the disciplined process which underpins it. It utilises the “Economic Advantage Process’”, which was born out of the Cross Report first written by fund manager Anthony Cross. He is joined on the fund by co-managers Julian Fosh, Victoria Stevens, Matthew Tonge and Alex Wedge.
The key belief is that only distinctive and hard-to-replicate intangible assets can form the basis of a sustainable competitive advantage. It is a process which has proved successful on both the Liontrust UK Smaller Companies and Special Situations funds.
This fund only invests in profitable companies, which also have at least one intangible asset – these include a strong distribution network, high recurring revenues, or a strong brand. The team also looks for director ownership of at least 3 per cent of the company.
Matthew Tonge says these tenets behind the process have been integral to the fund’s success since its launch in 2016. In that time, it has returned 125 per cent, while the UK’s largest 100 companies have returned 50 per cent*. That’s impressive in a climate of Brexit, Covid and now inflation.
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A holding in online firm Gear4Music is a great example of the process at work. It has grown to be the largest retailer of musical instruments in the UK, taking share from high street shops. “There’s only so many drumkits you can have in the shop window, that’s not the case online,” adds Matthew.
The company had great success during Covid with its shares rising five-fold, but wider issues with shipping and cost hit the business towards the end of the pandemic – none of which were its fault. The share price has since returned to pre-Covid levels***, something Matthew feels should not be the case.
He says: “The founder has realised the opportunity in Europe and built distribution hubs and stocked them, as well as buying a complimentary business. He’s not thinking about where my shares are now, but is focused on the long-term, highlighting the power of direct ownership.”
What I like is the eclectic mix of UK plc this fund has to offer. It can range from a successful asset management firm like Gresham House to a smaller business with exceptional potential for growth.
Examples include Vianet Group, which not only monitors beer flow from barrels in the bottom of a pub cellar to the till, but also invests in telemetry boxes in vending machines – effectively monitoring stock levels and conducting contactless payments. It has over 300 customers, including blue-chip companies.
Perhaps the quirkiest of all is a holding in Bigblu Broadband – a Bicester-based business providing satellite broadband to rural Australia and parts of Scandinavia.
What we really like is the team’s ability to keep taking advantage of their window of opportunity. They form partnerships with the businesses they want to work with and those that graduate from the Micro Cap fund can go into the firm’s market leading small-cap fund – a good example here would be Keystone Law, which has become the largest network law firm in the UK.
Micro-caps are not for the faint hearted but they also offer outstanding growth opportunities. We like the team’s disciplined process with the fund only focusing on companies which already generate a profit. Co-manager Victoria Stevens describes it best: “We don’t mind ‘jam tomorrow’, as long as we’ve got bread and butter today.”
*Source: FE Analytics, returns in pounds sterling, figures from 9 March 2016 to 13 July 2022
**Source: Google Finance
Past performance is not a reliable guide to future returns. You may not get back the amount originally invested, and tax rules can change over time. The views expressed are those of Juliet Schooling Latter, research director at FundCalibre, and do not constitute financial advice.