High income yield and growth via microcap companies

Think of high yield or high income, and small caps and microcaps are probably not going to be the type of companies that would immediately come to mind. There is a good reason for that: almost every equity income fund in Australia is made of large cap companies. In fact, if you look under the bonnet of most equity income funds, they are very likely to be composed of a few core companies; the big four banks, and add in Telstra for good measure. Outside of these companies, the funds will probably use artificial adulterated enhancers such as derivatives to derive (pun fully intended) additional income. These two factors should make investors wary; there is an awful amount of concentration risk in most equity income funds, and the use of derivatives adds an extra layer of potential risk. The Microequities High Income Value Fund has none of those trappings. Firstly, it has a diversified source of 27 profitable, growing, dividend-paying industrial microcap and small cap companies. Secondly, the fund is completely vanilla in structure: it has two simple types of assets; cash and equities. It doesn’t use derivatives to artificially boost its income generating capacity. It has no leverage of any kind (which some equity funds use to boost yields), and has no short positions. Vanilla, plain and simple.

27 profitable businesses

The 27 profitable, growing companies that make up the funds constituents have been assessed by the Microequities investment management team as businesses that have economic prospects and business models that will provide for a long term sustainable dividend income stream, in addition to capital growth potential.

High Yield

The Fund’s portfolio constituents are expected to produce an aggregated 8.6% grossed up dividend yield. This expected income yield is not reliant on any single company, but sourced from the breadth of the portfolio of profitable microcap and small cap companies. In addition to income, the fund has demonstrated its capital growth capability thanks to a combination of the underlying earnings growth of its constituents and the Microequities value investing discipline.

How is High Yield achieved?

There are typically 3 distinct scenarios that allow us to find undervalued profitable companies with a high dividend yield:

1. Unknown companies: These are typically microcap companies that, because of their relative scale and the focus of the investment community on much larger companies, are simply not well-followed or invested from an institutional perspective. This provides us with an undervalued investment opportunity

2. Low capital intensity: Some business models, such as professional services firms, are light in term of capital expenditure intensity. The growth of these companies and business models do not require large capex commitments in order to expand the productive capacity of the enterprise, as their capital bases are derived from human capital. If they want to expand productive capacity, they need to expand their human capital, i.e. hire more people. Consequently, the dividend payout rate (dividend per share / earnings per share) is usually high, typically in excess of 70%.

3. Unloved and misunderstood: Sometimes erroneously referred to as “turnaround stories”. These are business which are simply misunderstood, unloved, and unwanted as a result of the prevailing view within the investment community, and due to their suppressed market values, their equity can be purchased at high dividend yields.

The track record

The Microequities High Income Value Fund has been running for almost 5 years, and since inception (March 2012) it has achieved a net compound return of 15.55% (after all fees). That number doesn’t include the franking credits which the fund pays in addition to the cash distributions. Including the franking credits would add almost another 2% to the total returns. The fund pays cash distributions every six months, and has never failed to make a cash distribution. The sustainability of those cash distributions is underpinned by 27 growing, profitable industrial microcap and small cap companies, and yes, you guessed it, the fund doesn’t own any of the big four banks or Telstra.

Tag: high income