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Micro Cap Flash 2014 Q4
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“Cleverness is good, patience is better.“
— Herman Hesse
WILL 2015 PERFORMANCE FOR SMALL CAPS COME CLOSER TO 2014 — OR 2013?
During 2013 patience was rewarded as micro caps advanced 45% and the Uniplan Micro Cap Portfolio gained 52%. The returns were less spectacular during 2014. In a digital world where communication is instantaneous and markets are constant, the notion of waiting for return seems obsolete. In fact, according to the NYSE, the average holding period for common stocks has declined from 6.3 years in 1970, to about 10 months in 2013. In micro cap land, voluminous amounts of patience and long holding periods are often required for business plans to materialize and markets to recognize progress. During 2013, the patient micro cap investor was rewarded for staying in the game, during 2014 micro caps essentially marked time.
For the year-to-date period ended December 31, 2014 the preliminary estimated investment results for the microcap portfolio are as follows:
THE YEAR IN REVIEW – 2014 SNAPSHOT
As we detailed in our Q1 2014 Flash Report last year, we viewed 2014 as a transition year for both micro caps and the broader economy. As such we undertook a rigorous portfolio review with the idea of reducing risk and harvesting some long term gains to prepare for a reallocation process.
The year started with a high level of economic and market uncertainty. Micro Caps seemed to show no clear broad thematic long-arc paradigms outside of increasing M&A activity which we expected due to the large volumes of private equity and relaxed underwriting standards on debt. However, we created a list of our “Top Ten Thematic Ideas” which we use as a macro framework for idea generation among companies that meet our value screening criteria. The top ten themes are as follows:
With the exception of a few special situation names, most of our holdings are now related in some manner to the themes listed above. Similar to last year, 2014 brought a modest uptick in M&A activity within our portfolio. Three companies were lost to deal activity. Two additional companies which were on our watch list as possible investment candidates were also involved in transactions thus limiting some of our opportunities. This compares with three deals in the portfolio during 2013; up from one deal in 2012 and two during 2011 but still below the average of five deals annually which was the norm through 2010.
(Source: Uniplan Investment Counsel, Inc.; Baseline)
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 $9 trillion of cash and equivalents on their balance sheets at the end of 2014; 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 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 year-end, the average dividend yield in the micro cap portfolio stood at around 1.6% which is an encouraging positive indicator of valuation given the low interest rate environment.
Within the Micro Cap Portfolio, our sector weightings have remained overweight the technology sector and underweight the financial sector. Within the technology space there remain many interesting companies which are trading at reasonable prices and remain very profitable despite some lack of growth due to the subdued economic environment. The financial sector, which is the largest sector within the micro cap benchmarks, remains underweight in the portfolio as many small financial institutions remain only marginally profitable due to low net interest rate margins and modest loan demand.
(Source: Uniplan Investment Counsel, Inc.; Baseline)
As we review the portfolio from an attribution perspective, our stock selection continues to be the main contribution to performance differentiation. Our selections within the technology sector were the best contributors to portfolio performance along with energy selections which were very difficult to navigate during the second half of the year. Our sector allocation was the largest detractor from portfolio performance with our cash holdings being the largest drag followed by our healthcare selections, most of which are in the medical device area and were generally hurt by the device tax imposed by the Affordable Healthcare Act. In addition, micro cap biotech and bio-pharma names were very explosive this year. Most of these are considered development stage companies and have little or no revenues or cash flow which generally excludes them through our screening process. Thus we did not participate in the large moves these stocks provided within the benchmark.
(Source: Uniplan Investment Counsel, Inc.; Baseline)
CONCLUSION
With the lack of participation in the microcap universe relative to the broader market, we expect 2015 to provide an excellent new group of possible micro cap investment opportunities for investors who do their homework. 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 2015, 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 microcap space seems to be nearly universal. We continue to position 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 microcap 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, 2014 is 18.1% for the composite and 26.5% 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.
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