‘Pick the right ones that are not driven by short-term incentives’

The managing director of quoted investments at Gresham House, a specialist alternative asset manager, suggests this means there exist many “under the radar” stocks where investors can find opportunities.

We are specialists investing at the bottom end of the market

In 2018, Livingbridge – a mid-market private equity company – sold its fund and investment management business to Gresham House, and Mr Wotton was appointed to his current role, where he looks for “good quality companies that have had long-term growth potential”.

He explains: “We are specialists investing at the bottom end of the market, that is what we have always done.

“We are a niche in that we focus on the smaller end of the market, within the UK Smaller Companies sector.”

He adds: “[And] there are loads of opportunities because there are loads of companies under the radar.”

Drawn to diversity

“The good thing about small-cap is the sheer diversity of companies; big companies are interesting until you have learnt quite a lot about them,” says Mr Wotton.

“My primary motivation is being intellectually stimulated and learning new things, finding a new company and learning about its business model and meeting new people,” he continues.

“It is an interesting industry and you get to interact with senior managers and board members of companies that are growing, are dynamic, and doing something different.”

If the large-cap is FTSE 100, then mid-cap is anything from £1.5bn to £5bn market cap and small-cap is below £1.5bn, while micro-cap is anything below the £250m market cap, according to Mr Wotton.

Few invest in small-cap companies, largely because they are not very well researched.

Mr Wotton explains: “In order to be viable for a research analyst to cover a company, they have got to effectively believe there is a good chance they can win the mandate... and the bigger the company gets, the more viable it is to cover it.”

He suggests Mifid II has “made it even less economic” for analysts to research smaller companies, because “they will have to be very clear that they can justify their coverage and allocate their time to genuinely create revenues”. 

He adds: “If they cannot do it by being paid for the research, it is not viable... there has been a reduction in the average number of analysts doing this research, and the smaller you go the less there are.”

So in his role, Mr Wotton says he looks for companies likely to perform well even in times of economic strain, due to structural growth in their niche market, or “because they have a unique position or specialism and competitive advantage that is likely to endure a number of years”.

He continues: “Even if Brexit wrecks the economy and it is complete Armageddon, the majority of the companies – if we have got it right – should still be able to grow their profits materially over the life of our investment.”

Avoid cyclical areas

Smaller companies generate an interesting opportunity in the current economic climate, reiterates Mr Wotton.

He says: “We try to avoid overly cyclical areas and sectors where there are big external factors which are going to make or break the investment case. 

“But we also do not invest in really early-stage companies where they are still trying to prove whether they have a market at all or whether their business model works.”

Sectors Mr Wotton does invest in include profitable software or information technology services, businesses such as cloud hosting businesses or IT management services.

He says: “If there is a slow down or a recession in the UK economy driven by Brexit or anything else, then that is clearly going to have a major impact on firms all over the place. 

“[But] certain sectors are going to be disproportionately affected by that, including real estate or real estate-related businesses and retail.”

He continues: “Whereas if you want to be in consumer and retail you want to be in sectors that are more resilient because they are value-focused or they are in a structural growth area.”

While he acknowledges smaller companies on average are a riskier asset class, some of the risk can be mitigated by ruling out some sectors. 

He adds: “That tends to take out some of the more volatile and more binary investment cases, like biotech for example.”

Taking the long view

While an area might be perceived as high risk, it is likely to deliver more capital growth over the longer term.

For this reason, small companies significantly outperform large companies over the longer-term, according to Mr Wotton.

He says: “It is about trying to pick the right ones who have that longer-term view and are not driven by short-term incentives. 

“Try and shut out the noise... there is a whole host of small companies out there that pay attractive dividends and growing dividends because the companies themselves are growing.”

Victoria Ticha is a features writer at Financial Adviser and FTAdviser.com