Micro cap stocks

The River and Mercantile UK Micro Cap Investment Company (LSE: RMMC) is one of only a few funds which primarily focuses on some of the smallest UK companies on the stock market. It aims to achieve long-term capital growth by investing in companies with a market capitalisation of less than £100m at the time of purchase.

Although the fund is relatively new, launched less than three years ago in December 2014, it has so far performed well. The investment company was one of the top-performing small-cap funds over the past year with a 12-month net asset value (NAV) return of 47.8%, which compared favourably against the Morningstar UK Smaller Companies category performance of 26.2%.

Greater scope for growth

Portfolio manager Philip Rodrigs reckons the smaller the initial size of the company at the point of investment, the greater the scope for growth. Micro caps are one of the less-researched areas of the market, meaning diligent investors may earn big returns from finding small, quality companies that have been undervalued for a long time before being discovered.

The fund’s outsized exposure to the technology sector, which accounts for 29.7% of its portfolio allocation (against just 8.9% in the benchmark index), has no doubt played a big role in the fund’s performance. However, looking ahead, it’s important to be wary of the fund’s concentration risks. Although the UK technology sector is in good health at present, high valuation multiples among many tech stocks may limit further upside potential.

The fund is also meaningfully overweight in the oil and gas sector, which represents 11.5% of its assets — compared to the benchmark weight of 4.5%. And as a result, the fund is underweight in a number of other sectors, most notably industrials and financials. Top holdings include Microgen (5.9%), Taptica (5.4%), Blue Prism (5.2%), MaxCyte (4.8%) and Ideagen (4.4%).

European small-caps

For investors looking to diversify away from UK stocks, the TR European Growth Trust (LSE: TRG) is perhaps a better pick. The Janus Henderson trust invests primarily in smaller and medium-sized European companies, with the same aim: to achieve long-term capital growth.

The top three country exposures are Germany, France, and Italy, which represent 19.4%, 12.3%, and 11.5% of its portfolio, respectively. The trust also invests most heavily in the industrial goods sector, carrying a hefty 23.6% exposure to it. Top holdings include Van Lanschot Kempen (2.3%), Brainlab (2.2%), FinecoBank (1.7%), Anima (1.3%) and Lenzing (1.3%).

Further to run

Ollie Beckett, who has run the fund since 2011, reckons the European recovery story has further to run. Despite the narrowing valuation gap between US and European stocks over the past year, he believes there are still undervalued growth opportunities in the market.

The TR European Growth Trust is a top-quartile performer, with a five-year cumulative NAV performance of 230.8%. Its stock performance is even more impressive, with a total share price return of 320.9% over the same period, thanks to a narrowing of its discount to NAV from roughly 20% in 2012, to currently less than 1%.

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Jack Tang has no position in any shares mentioned. The Motley Fool UK has no position in any of the shares mentioned. Views expressed on the companies mentioned in this article are those of the writer and therefore may differ from the official recommendations we make in our subscription services such as Share Advisor, Hidden Winners and Pro. Here at The Motley Fool we believe that considering a diverse range of insights makes us better investors.