Downing Strategic Micro-Cap (DSM) reported annual results to 28 February 2021, with the portfolio delivering a 26% increase in NAV and the shareholder return coming in at 22%.
‘We believe that the portfolio sits at a 43% discount to its intrinsic value’
DSM’s manager, Judith MacKenzie, had this to say: “I said back at the time of the Interim Report in 2020 (issued in November) that I didn’t know what I would be writing at the time of the full-year report in May 2021. The complexities on the world stage at that point were multiple; a Brexit deadline was looming, the threat of a 2nd or even 3rd lock-down looked inevitable, vaccines were being validated but not rolled out, and of course, we were on the eve of a tumultuous US General Election. At that point, my fortune cookie had to forecast the outcome of these issues, whilst at the same time we had to evaluate their impact on our portfolio. Clearly, this was challenging, but we had formed a view in early 2020 that we could only focus on what we know – which is our underlying investments.
Six months seems to have been a long time this year, but in other ways it seems surprisingly short. I am more relaxed about the US – or am I? Biden is creating fiscal stimulus through infrastructure commitment. But who is paying for it? We have a vaccine roll out program – so I should be less concerned about covid, surely. But who is paying for the fiscal support? Brexit – done and dusted aside from a couple of supply chain issues and a disgruntled Northern Ireland. But who is paying for the regulatory and operational change it has brought? Apparently, I need not worry, as markets are at all-time highs. But I am still left thinking, ‘who is paying for it’?
I am clearly in a minority when it comes to questioning the fundamentals. US margin debt has risen to a record peak of $822bn in March, the popularity of SPACs and the fact that the cryptocurrency market is worth more than all listed US banks combined, would in normal times give reason for concern. However, as the year progresses, I suspect we will still be living the 1920s-like euphoria for some time, even if I am still asking who is paying for it.
If we, therefore, assume that there might be a stock market bubble looming, then we have to look at the impact it might have on our portfolio. Firstly, booms or bubbles are typified by 5 main stages:
1. The theory of displacement, or that the world will follow a new paradigm. We have seen the popularity of healthcare and technology stocks in the last 12 months, for example.
2. Boom – yes, we can tick that box. The US market is at all-time highs. The Leisure Sector in the UK is at the same rating as it was pre-covid; despite lockdowns.
3. Euphoria – yes, we can say there is evidence of this. The number of IPOs and fundraises in the EMEA market is at its highest level since 2000 (Q1 2021)
4. Profit taking – not seeing that yet.
5. Panic – still to come?
As managers, we have a belief that it is difficult for the central banks to step away from pushing money into the economy, and that the public could spend their way out of a recession. But at the same time, we have a conviction that the symptoms of a bubble, described above, are there. So, what do you do? Becoming too defensive means you miss out but electing to ride the momentum seems foolhardy.
Being a stock-picker in this environment is the most comfortable place to be. You are not buoyed by sector movements; you have the luxury of looking at fundamentals and taking a view as to how future cash flows and assets can be valued. Being able to hunt for the strategic catalysts that can drive value is a more comfortable place to be than trying to value the next IPO.
We have always tried to quantify the inherent value within the portfolio – based on our own judgement of current and future earnings. Thereby trying to cut through the ‘market noise’ against or for our type of investing. If we purport to understand our underlying investments better than anyone else, then we should theoretically understand how to value them better.
As we stand today, we believe that the portfolio sits at a 43% discount to its intrinsic value. Coupled with that there is a 14.2% discount to the net asset value reflected in the current share price.
So, we are focused, alongside strong management teams, on the catalysts in the portfolio. Meanwhile, the sentiment towards value is improving, whilst there is a focus on UK small-cap which has been an underdog for many years. We believe it is a good time to be an investor in this asset class.”
DSM: Downing Strategic Micro-Cap sees further headroom for UK small-cap following several years of underdog role