Companies with robust balance sheets and cash flows are key investment screens for us – we operate a ‘quality’ process. This is protecting the portfolio and has led to good relative performance since the beginning of the year (being 6% ahead of the peer group* average in the year-to-date), continuing the excellent relative performance of 2019.
We have been very pleased by the manner in which our companies are dealing with this crisis, communicating clearly with their stakeholders and the investment community. Their recurring revenues and mission critical nature were always likely to support them in this scenario and so far this seems to be playing out. The exceptions are those companies with significant exposure to the leisure industry and we have sold all 3 of those investments. For these 3 investments neither can we predict when demand will return to normal, nor forecast the financial strength of their customers who are operators of bars, hotels and restaurant chains.
As a consequence of two of the leisure-exposed companies being micro-caps, the portfolio has reduced exposure to micro-cap names, which have historically been a significant contributor to the outperformance. 2019 saw 3 takeovers of the smallest companies. Of late, Castleton Technology has had a takeover offer and Cerillion released a very positive trading update, however, most of the handful of micro-caps we held have been sold – market liquidity could face further tests yet and we have never felt better positioned in that regard.
When a sustained economic recovery is underway, we will look more favourably again on micro-caps. However, the timing and type of the recovery is very unclear as I write today. This is not a moment to be taking risks for our AIM Portfolio clients.
So what have we done with the cash from the investments that have been sold?
We have invested in four new additions which, like the other portfolio companies, have the cash to ride out the storm. We think that they will be in stronger market positions on the other side. In end-markets which will be just as strong, if not stronger, as they are exposed to different structural growth areas. These are net cash businesses with the high profit margins that we require. Their lack of capital intensity has meant they have not recently undertaken a dilutive share placing to finance their future growth. The next quarterly factsheet will disclose these new additions.
If we can continue to manage the risks, and correctly identify structural growth themes accessed through high margin, recurring revenue businesses run by great company management teams, then this should lead to a defensive relative performance over time.
*Peer Group is IA UK Smaller Companies and performance figures obtained from FE Trustnet, data as at 23.04.20. GBIM AIM Portfolio Service performance is a representative sample.