AIM Industry Report 2017/18

50 51 12 sectors at present. We are very much long- term investors and our approach to investing has remained consistent over the last 11 years of managing AIM IHT portfolios. During this time, we have built up holdings in a strong core of profitable companies which we believe have a sustainable business advantage and the capacity to grow. The great joy of investing on AIM is that you really are looking at the individual merits of each company and you will often find something new, interesting and disruptive in sectors that are deeply out of favour with more established companies. In terms of what looks particularly interesting to us at the moment, I would highlight Telford Homes. They plan, design and build apartment developments on brownfield sites in non-prime locations in London. What currently excites us about Telford is that it has begun focusing on build-to-rent projects, which are forward funded by institutional investors. We view this as a positive move given the improved visibility and higher returns on capital that they provide. JG: I agree with Matt and think the beauty of the small cap market is really the diversity of companies and business models you can find. You don’t necessarily have to be in a sexy sector in order to generate shareholder returns. Equally a business in a fashionable sector doesn’t necessarily guarantee stellar performance either. I think the key is whether the company has the managerial quality and financial flexibility to be able to capitalise on the growth opportunities ahead of them. We’re sector agnostic in that respect and tend to look for the fundamental profit drivers behind each company, be that secular growth, technological disruption, management self-help or improving efficiencies. A good example of this would be Victoria PLC. A few years ago there was a change in management and Victoria since then has been transformed from a relatively sleepy predominantly UK-based carpet manufacturer to one now with aspirations to consolidate the broader flooring industry across Europe. The share price performance so far has been very good and I think in part that reflects the success that they’ve had in the UK but also the opportunities that lie ahead. The European flooring industry remains quite fragmented, very similar to the UK carpet industry a number of years ago, and there are lot of small and sub-scale operators out there that would benefit from being part of a larger group. I think there are quite a lot of opportunities out there but it requires a diligent manager to be able to look under the hood and see longer- term. Of course, we’ve had exposure to cyber security and changing consumer behaviours but it is interesting that often you’d find some of the best performers over the years have come from fairly unexciting places and I think that will continue to be the case. SP: We have built our Adapt AIM portfolios using a “bottom-up” approach, and therefore we don’t focus on sector allocations, but rather choose those companies that fit our investment criteria. As such, our growth portfolio has a slight skew towards technology companies, whilst income is broadly invested across dividend paying stocks. A couple of recent additions to our portfolios that we are excited about are Strix, the global leader in kettle controls, which recently came to AIM and Castleton, a provider of integrated software solutions to the Housing Association market. SD: We are broadly sector- agnostic. There is one exception, and that is that we have a prohibition on investing in companies in what we consider to be the resources sector, so oil and gas companies, mining companies. Anyone who has an exploratory part of their business, be it trying to find uranium in Tanzania or gas in the North Sea. We removed that sector completely simply because historically on AIM there have been some absolutely catastrophic losses of shareholder value in those particular sectors because of the nature of exploration rights. Beyond that, our interest remains in UK business, so UK domiciled companies or ones domiciled in the Channel Islands, which are dividend-paying, positive- earning, good value that qualify for BR. WITH AN INCREASING NUMBER OF AIM BR PRODUCTS COMING INTO THE MARKET, DO YOU HAVE ANY CONCERNS ABOUT A BUBBLE IN SOME STOCKS? MS: Yes. There are a number of AIM companies that are heavily owned by BR seeking investors and where the valuations look stretched. Our concern is what would happen to them if they were to no longer qualify for BR; it could get ugly. However, there are still many companies expected to qualify for BR who offer attractive prospects and valuations. In particular, we are seeing attractive valuations in some of the smaller AIM quoted companies and also those with a greater exposure to the UK economy. Given our size we are nimble enough to hold some of these smaller names in the portfolio. One of our portfolio holdings at the smaller end of the market capitalisation scale is Murgitroyd. They are a trademark and patent attorney with their headquarters in Glasgow and offices in the UK and across Europe. Although the company issued a disappointing trading statement in January 2017, we have met with the CEO a couple of times since and he reassured us that the business is healthy. Murgitroyd has a progressive dividend policy and we believe that its valuation is attractive given its future growth prospects. SP: As the size and number of AIM Business Relief products increase, there is definitely a risk of certain, favoured companies gaining inflated valuations. With two smaller funds and a historic focus on Small and Mid-Cap companies, we are able to cast our net wider and this results in two portfolios that look quite different from most other AIM Business Relief products. SB: I’m absolutely concerned about a bubble. You look at the biggest constituents on AIM – I looked at the top ten the other day – and the average PE was about 40 times, which doesn’t leave you much wiggle room, and these are all billion pound plus companies. We’re much more value-based in the way we do things, so those just don’t come on our radar and I think if you scratch hard enough you can still find things. The great thing about AIM is that it’s quite a broad waterfront of 1,000-odd companies. So, there are still opportunities out there, they’re just getting harder to find and sometimes that means you’re coming down the market cap scale a bit. There can be more risk involved in those companies, whether that is expressed by share price volatility or just by the underlying operations of the businesses which may not be as well developed as their larger counterparts. JG: This is a good question. It’s an issue we’ve been mindful of for a few years now. The one thing I’d say is that price to earnings ratio can be a rather crude measure of valuation. It doesn’t take into account growth rates, balance sheets, or capital structure for example, but it does nevertheless suggest that a premium is being paid in some of the larger more liquid names in the AIM market. You could argue that this has always been the case but I think it’s certainly come into sharper focus with more entrants coming to the market and certainly as the popularity of BR investments has increased. To our minds, some of these valuations can be justified by the growth rates these companies are experiencing, the reliability of earnings progression or indeed the niche position that they have in an industry. But there are certainly some examples where I think the valuations do look stretched relative to the fundamentals and we do actively avoid them. Also, as a smaller player within the BR space, our modest portfolio does allow for flexibility to look further down the market cap spectrum (£50 - £200 million market cap) where the premium is perhaps less pronounced and actually, where most of our successes have come. I still continue to see that as a key area for finding the growth stories of the future. We do try and look for companies that are perhaps below the investing radar of the wider market. SD: We share the concerns of our peers, but our stock selection process screens out companies which are valued on a ratio which is higher than what we believe is conservative. So, we have an internal level which we set, which is relatively conservative, and screen out any companies that are valued above that to protect our investors against investing in companies which we see as being in a bubble. Examples of companies which we would consider to be incredibly over-valued on AIM would be companies like Asos and those which are trading on a 2, 3 or even 4 times higher ratio – a 400% ratio versus their comparable company which would be on the main LISA BEST ANDREW MARTIN SMITH SHARON PRIEST SAM BARTON MATT STRACHAN JUSTIN WAINE JON GOULD STEPHEN DANIELS “As the size and number of AIM Business Relief products increase, there is definitely a risk of certain, favoured companies gaining inflated valuations.” — SHARON PRIEST, BLACKFINCH INVESTMENTS “In particular, we are seeing attractive valuations in some of the smaller AIM quoted companies and also those with a greater exposure to the UK economy.” — MATT STRACHAN, THORNTONS INVESTMENTS “The greater concern from some is that certain stocks are owned in very large proportions by inheritance tax qualifying funds, or services. But I don’t think that it’s quite as marked as people believe.” — ANDREW MARTIN SMITH, GUINNESS ASSET MANAGEMENT