Go for small wins with Liontrust UK Micro Cap

These stellar returns and the appeal of backing high-growth companies might tempt you to dive into this part of the market. But the risk and volatility inherent in smaller company stocks, as well as the sheer amount of due diligence required to invest in them successfully, means that there is a strong case for getting exposure to this part of the market via a smaller companies fund.

While by no means a risk-free option, Liontrust UK Micro Cap (GB00BDFYHP14) taps into some of the greatest growth potential by investing in extremely small companies using a tried and tested approach. At the end of April, the fund had 80.5 per cent of its assets in Aim-traded stocks.

The fund only launched in 2016, but invests via an approach that has paid off over longer periods with other funds. Liontrust UK Micro Cap's managers, Victoria Stevens, Matthew Tonge, Anthony Cross and Julian Fosh, seek companies with a “durable competitive advantage” that allows them to sustain a higher-than-average level of profitability for longer than expected. This can take various forms, but includes intellectual property, strong distribution channels and significant recurring business. Liontrust’s team looks for companies in which the senior managers hold at least 3 per cent of the shares, because they think this indicates key employees are adequately motivated.

Some of the fund’s recent investments demonstrate this approach. In April, its managers bought Augean (AUG), which they consider to be “the leading hazardous waste management business in the UK”. This decision was based on the strength of Augean’s distribution network, high market share in various niche areas, and ownership of the governmental permits and licences needed to operate in a heavily regulated sector.

Liontrust UK Micro Cap's managers also back infection control and hygiene product provider Tristel (TSTL) for reasons including its intellectual property and distribution strength. And they recently bought into corporate promotional materials provider Pebble (PEBB), which has a strong presence in a niche market.

Liontrust UK Micro Cap’s quality bias, and low exposure to UK cyclical stocks and companies whose business relies on face-to-face contact, has given it some protection during this year’s sell-off. And the fund's managers' investment process has paid off handsomely with some of the other funds they run, such as Liontrust UK Smaller Companies (GB00B8HWPP49). But because Liontrust UK Micro Cap is much smaller, with assets worth just £80.4m at the end of May, it can invest in smaller companies that have greater growth potential.

Although Liontrust UK Micro Cap has been successful to date, it is still a high-risk investment, which is not immune to the ups and downs of small-cap investing or the challenges of the coronavirus crisis. For example, one of the fund’s holdings, Vianet (VNET), which provides data and analysis to pubs and vending machine operators, has seen its shares tumble amid the recent shutdown of the hospitality industry.

This fund's ongoing charge is also relatively expensive at 1.39 per cent.

However, this is partly due to Liontrust UK Micro Cap's size and should shrink if the fund continues to be successful and grows in size. And its managers record on this and other funds suggests that there is a good chance this will happen. So, in the meantime, it could be worth paying more for the specialist exposure this fund offers and the due diligence that requires, and the strong track record of the process behind the fund.

If you are seeking growth over the long term and have a high enough risk appetite to tolerate the many challenges smaller companies face, Liontrust UK Micro Cap's experienced managers, investment process and ability to hold up relatively well in volatile markets suggest that it could be a good way to achieve it. Buy.