Micro Cap Flash 2016 Q1

“Genius is nothing but a great aptitude for patience.“
— George-Louis de Buffon

PORTFOLIO CHANGES CONTRIBUTING FOR 2016

The Uniplan Micro Cap Portfolio is a low-turnover high-conviction micro-cap strategy designed to offer investors a quality alternative to private equity having a similar unlevered return while providing daily liquidity. The core investment thesis is focused on companies with little or no balance sheet leverage trading at a low multiple of cash flow or EBITDA, and having meaningful smart money activity in the form of insider buying, or 13G/13D activity.

During 2013, the patient micro-cap investor was rewarded with a 50%+ for staying in the game, during 2014 micro caps essentially marked time with a very volatile 2015 leaving the benchmark down -5.4% while our portfolios gained +3.9%; our value bias added value over the year as biotech and other more speculative micro-cap sectors gave back early year gains.

Late in 2015 we undertook a complete portfolio review with a rigorous reassessment of each of our holdings. This was designed to be somewhat like pruning a perennial garden with some plants needing to be culled in order to make room for more robust growers. We also moved back into a more risk-off position based on our 2016 earnings and economic outlook and our concerns over the potential for increasing volatility. In addition, we tried to harvest some gains and losses in a tax efficient manner to redeploy capital. For the year to-date 2016, the changes seem to be taking root as the portfolio has started the year with a positive contribution relative to the benchmark while doing so with far less volatility.

For the year-to-date period ended February 29, 2016 the preliminary estimated investment results for the micro-cap portfolio are as follows:

So, what might distinguish our current micro-cap holdings from other micro-cap managers as well as the broader market? In reviewing our attribution data, there are several thematic items that stand out. First, the Uniplan micro-cap holdings have virtually no direct exposure to the energy sector which continues to struggle. In revamping the portfolio, we also worked to reduce our indirect exposure by reducing or eliminating holdings that have indirect sales exposure to the energy sector.

Our underweight to the financial sector, which represents about 30% of the Russell micro-cap index vs. our 9% exposure also helped performance. We believe small financial company stocks have underperformed due to broad based concerns over volatility in interest rates and general credit concerns. Our portfolio is historically underweight financial stocks due to the relatively high level of debt leverage that is used on the balance sheets of those companies. This removes them from consideration early in our screening process which seeks to avoid too much debt on company balance sheets.

Stock selection has also been a large contributor to portfolio performance, with selection contributing about 766 bps to our overall portfolio returns for the year-to-date.

The areas where stock selection has made the largest contribution have been in the health care and consumer discretionary sectors contributing about +222 bps and +121 bps respectively with these sectors representing about 27% of the overall portfolio. The area where stock selection has been the weakest has been utilities and consumer staples, detracting by about -46 bps and -28 bps respectively; however these sectors have less benchmark and portfolio weighting than the contributing sectors and represent about 8% of the total portfolio.

THE STATE OF M&A

We continue to see MEGA deals play out in the M&A space but have yet to see a resurgence of activity in the micro-cap space. The question is whether the market conditions that have fueled mega merger activity will push down into micro-cap M&A in 2016?

The drivers behind M&A activity have been the abundance of corporate cash available to be deployed and the reemergence of reasonably priced bank financing for the deal community. Additionally, while less applicable to the micro-cap market, slow corporate earnings growth downstream of the recession has forced big corporations to seek growth externally rather than focus on organic increases in revenue.

Pitch book suggests that Private Equity has approximately $950 billion of “dry powder” available for deal-making through recent equity raises, along with a large portfolio pre 2007 seasoned companies that continue to roll, resulting in additional liquidity. The availability of debt continues to improve and be more accessible and that is helping to support valuations. E&Y’s recently published US Capital Confidence Barometer suggests that the robust M&A market will continue for the near term. A near all-time high of 78% of E&Y’s respondents believe that the M&A market will improve in 2016. The vast majority of deal-makers asked are evaluating more than one deal and almost half were considering more than five potential transactions.

In addition, E&Y reports that the middle market will benefit from this bullish outlook; this should have a positive impact on the micro-cap space as more money is deployed in the middle market which is the sweet spot for micro-cap transactions. The bid-ask spreads of price expectation have significantly shifted toward middle market deals over the past 12–18 months. As mentioned, until recently M&A markets have been led by large cap transactions, followed by a period of focus on the middle market as acquirers fully digest their large acquisitions and reshape their future plans. So far, 2016 is on course to meet this trend.

RECENT PORTFOLIO M&A

With that in mind, the first transaction in the micro-cap portfolio has already been announced in 2016. RR Media (RRM), a media services company which provides fixed and mobile satellite broadcasting services to other media companies, agreed to be acquired by European satellite services firm SES for $13.291 in cash; a 53% premium to the prior days closing price. The deal is expected to close during Q3 of 2016. This illustrates to us the embedded strategic and financial value of many of the companies in the micro-cap portfolio and the opportunity set available in the nearly 4,000 micro-cap companies that comprise our investable universe.

The investment banking community has not missed the fact that the collective cash on the balance sheet of the American industrial complex has reached an all-time high. As measured by net debt to equity, balance sheet leverage for non-financial companies is currently running at below 15%, a level unseen since the late 1950’s. And, according to Thomson Reuters’ data, companies around the world held almost $11 trillion of cash and equivalents on their balance sheets at the end of 2015; that is more than twice the level of 10 years ago. And, capital expenditure relative to sales is at a 22 year low while the average age of corporate fixed assets and equipment has been stretched to 14 years from pre-crisis norms of about 9 years.

In the large-cap world, some of this money has been returned to shareholders in the form of share buybacks and dividends often times with the encouragement of dissident shareholders and corporate activists. In micro-cap land, there have been very few share repurchases, but dividends and special dividends have become far more widespread. As of February 29, the average dividend yield in the micro-cap portfolio stood at around 2.19% which is an encouraging positive indicator of valuation given the low interest rate environment.

CONCLUSION

With corporate cash at an all-time high, we believe any combination of improved earnings and economic outlook will give buyers the confidence to more vigorously step back into the M&A Market. We anticipate there will be continued volatility during the balance of 2016, as factors such as the global economic outlook and the strong US Dollar continue to cause uncertainties around earnings and economic growth. But, valuations remain attractive for many micro-cap companies and as a contrary indicator, the lack of investor interest in the micro-cap space seems to be nearly universal. We continue to position in new opportunities within the portfolio that appear to have good long term value. Thus, we continue our deployment of portfolio funds with a focus on our thematic framework and increasing the quality of names within the portfolio with dividend yields as an added bonus if available in good quality micro-cap opportunities.

Richard Imperiale
Portfolio Manager

Information: 1. Uniplan Investment Counsel is a boutique investment firm, with roots dating back to 1984 that manages a variety of portfolios primarily for US clients. Uniplan maintains a complete list and description of composites that is available upon request. 2. The composite was created August 1, 1999. Performance is calculated in US dollars utilizing a time-weighted total rate of return. Total return for the composite is represented by the asset-weighted returns of the portfolios within the composite. Trade-date valuation is used. 3. Gross performance is net of all transaction costs and net performance is net of transaction costs and investment management fees, but before any custodial fees. 4. The benchmark for the composite is the Wilshire US Micro Cap Index that represents a float-adjusted, market capitalization-weighted portfolio of all stocks below the 2,500th rank by market capitalization in the Wilshire 5000 at March 31 and September 30 of each year. The index is used to measure small stocks and is adjusted to reflect the reinvestment of dividends, when applicable. It is not possible to invest directly in an index. The index figures do not reflect any deduction for fees, expenses or taxes. 5. The dispersion of annual returns is measured by the standard deviation of asset-weighted portfolio returns represented within the composite for the full year. The standard deviation of the annual returns for the period August 1, 1999 to December 31st, 2015 is 17.9% for the composite and 26.07% for the benchmark index. 6. The composite does not have a minimum size criterion for composite membership. All fee-paying discretionary accounts with similar investment objectives are included. Leverage is not used in this composite as a means to generate higher returns. There is one non-fee paying portfolio in the composite. 7. There have been no changes in the personnel responsible for the management of this composite. 8. The composite contains both traditional and wrap fee portfolios. Uniplan has a flexible and negotiable fee schedule reflecting the differences in size, composition and servicing needs of clients’ accounts. A complete description of investment advisory fees is contained in Uniplan’s Form ADV and is available upon request. 9. Individual account performance may vary from the results shown because of differences in inception date, restrictions and other factors. Past performance is no guarantee of future results. 10. Investors should understand that micro-cap stocks are subject to a higher degree of risk than other equity investments due to the small size of the companies and the limited trading volume inherent in micro-cap stocks.

All investments carry a certain degree of risk, including possible loss of principal. REITs are subject to illiquidity, credit and interest rate risks, as well as risks associated with small- and mid-cap investments. It is important to review your investment objectives, risk tolerance and liquidity needs before choosing an investment style. Value style investing presents the risk that the holdings or securities may never reach their full market value because the market fails to recognize what the portfolio management team considers the true business value or because the portfolio management team has misjudged those values. In addition, value style investing may fall out of favor and underperform growth or other style investing during given periods.

Uniplan Investment Counsel, Inc. (Formerly known as Forward Uniplan Advisors) is a registered investment advisor. The views expressed contain certain forward-looking statements. Uniplan Investment Counsel believes these forward-looking statements to be reasonable, although they are forecasts and actual results may be meaningfully different. This material represents an assessment of the market at a particular time and is not a guarantee of future results. This information should not be relied upon by the reader as research or investment advice regarding any particular security. Past performance does not guarantee future results. Prices, quotes and other statistics have been obtained from sources we believe to be reliable, but Uniplan Investment Counsel cannot guarantee their accuracy or completeness. All expressions of opinion are subject to change without notice. It should not be assumed that recommendations made in the future will be profitable or will equal the performance of this security. A list of securities purchased and sold in the portfolio during the past year, including the purchase or sale price and the current market price, is available upon request by calling 262-534-3000.