More private investors are beginning to buy into Alternative Investment Market (Aim) shares now that they can hold them in their individual savings accounts (Isas), as reported in this week's Your Money section. But Gervais Williams, fund manager at Miton Group, is already very involved with this market via his CF Miton UK Smaller Companies Fund (GB00B818N094), which had nearly 80 per cent of its assets in Aim shares, as at the end of July.
"I am not concerned whether a share is listed on Aim or the main market, rather it is the quality of the underlying companies," he says. "But the risk/reward balance for some Aim companies is extraordinarily attractive."
Some smaller companies have been on much better valuations than larger ones, such as trading platform Plus500 (PLUS) with a prospective yield of 6-8 per cent, and off-licence operator Conviviality Retail (CVR).
Other Aim shares held by CF Miton UK Smaller Companies Fund include International Greetings (IGR), Amino Technologies (AMO) and Dart Group (DTG).
He says allowing investors to include Aim shares in Isas will boost this market. "The government is also looking to reduce stamp duty on Aim shares which should encourage even greater interest in these," he adds. "This is the start of a trend which is just beginning, and Aim should be one of the best-performing areas over the next five to 10 years. There is so much value in some of the companies, although this will not come out in a year or two. We are very excited about some of the shares we own. There are also some stunning companies on the FTSE Fledgling Index, but by numbers there are loads of small and micro caps on Aim."
Read more on funds invested in Aim
Also see Cavendish Aim fund manager Paul Mumford's suggestions
Aim shares have their risks as well as their rewards. "These can be more vulnerable and if you get it wrong, you can lose all your capital," says Mr Williams. "You have got to be willing to invest in a range of companies. And we try to understand what the company directors are trying to achieve - we get great access to management teams and so get a better understanding of their thinking."
Mr Williams anticipates an investor move towards small caps in general. "Emerging markets such as Brazil and Russia are not growing so much, while it is harder for larger companies to grow. This should drive many investors to small caps, especially as there are ones which will grow irrespective of credit conditions. The great advantage of a small company is that it can double in size irrespective of the wider economy going forward. It is easier for them to grow organically: for example, a company of 10 people can go to 20 people, but it is harder to double when you have a 1,000 plus employees."
Small-cap yield
Small-cap yield has been an area of focus for Mr Williams over the years (see our last interview with him), and is part of the remit of his Diverse Income Trust (DIVI), which seeks income from shares across the market capitalisation spectrum. He also does not avoid income-bearing shares in CF Miton UK Smaller Companies Fund.
"I hold some companies in both funds because if you can have a great yield and growth why not?" he asks. "However, the Smaller Companies fund has no yield requirements so we can put ones in we think will pay a yield in, for example, three years. We will then look to put them into Diverse Income Trust, so in some ways Smaller Companies is a nursery fund. But I would like all our companies to produce a decent yield in a few years' time as yield and growth of income is a pattern which will be with us for years. You can't rely on the stock market going up, so you need companies of which the share price will increase irrespective of this - a reason why income is important. During the 1980s some of the best valuations were on shares which had long records of paying dividends and income, and that pattern will return.
"Overall attitudes to dividends have changed markedly among shareholders and a much wider range of companies are starting to pay good and growing income. There is greater interest in small caps offering a yield."
Seeking a high-yielding small-cap income stock is not that different to selecting a large one.
"In both areas, you want companies which are enjoying turnover growth and that needs to be sustained over the next two or three years," says Mr Williams. "They also need to have strong balance sheets so that they do not just grow their businesses but are resilient and can sustain their dividends. Some large companies have strong balance sheets but not that many, a reason why only about 9 per cent of Diverse Income Trust's assets are in FTSE 100 shares. Exceptions include BSkyB (BSY), a purchase earlier this year which has strong turnover growth and will grow consistently in coming years."
Other purchases this year include GlaxoSmithKline (GSK), when its share price fell back, and Premier Farnell (PFL) which "has very strong cash distributions and positioning going forward".
Also see our interview with IC Top 100 Fund Acorn Income's managers
But in the Smaller Companies fund he will be sticking to just these. "A lot of smaller companies funds have a large weighting in mid caps, because small caps have underperformed mid caps. But going forward small caps will be best."
Read more on funds invested in mid-caps
"Many smaller companies funds have also grown quite large so it is hard for them to invest in a company with a market capitalisation of maybe £25m," he adds. "But being a small fund (CF Miton UK Smaller Companies has assets of about £7.3m) is an advantage because you can get in."
