AIM Portfolio Service: Manager’s Commentary – Q3 2023

In the third quarter of 2023 our AIM Portfolio Service returned -6.84%, compared to the benchmark Numis Alternative Markets (Total Return) Index which returned -3.24%.

The third quarter of 2023 proved to be another frustrating period for AIM market returns. The Bank of England (BoE) increased the base interest rate by a further 25 basis points to 5.25% during the August meeting in a continued effort to curb inflation. At the most recent monetary policy meeting in September, the BoE decided not to raise rates, breaking a run of 14 consecutive rate rises.

Inflation has fallen materially from the 11.1% witnessed in October last year, to 6.7% for the August reading. Whilst this is still elevated, the trends are encouraging and with there being a lag before rate rises affect the real economy, suggests we are at or near the end of the rate hiking cycle. Potentially ushering in a more positive environment for AIM market returns looking forward.

Portfolio holdings

Strix, the global market leader in the supply of Kettle controls, fell by 49% during the quarter. Management reported the anticipated recovery of volumes in key export markets had not occurred in the manner previously expected. The fourth quarter is always the strongest trading period for the business due to stock replenishment and seasonal uplift, however, the shortfall versus expectations at this stage is too large to overcome to meet full year targets. Strix is a relatively small position in the portfolio, we continue to monitor matters closely and have discussed these in detail with management.

YouGov drifted 26% lower in the third quarter. The online research data and analytics group provided an update where they stated that due to longer sales cycles and some protracted client decision making at the start of the year, revenues would be towards the lower end of the expected range, implying circa 20% growth. However, due to improved profit margins, overall profit is expected to be in-line with expectations. Earlier in the quarter they announced the acquisition of the consumer panel business of GfK SE, who had been forced to sell the asset to satisfy the regulatory approval of their acquisition by NielsenIQ. It appears to be an attractive acquisition for YouGov and the company remains a high conviction investment.

Learning Technologies Group was also weak during the quarter, falling by 22%. In July the business reported that although the recurring SaaS based and long-term contracts have remained resilient, the transactional and project-based work has been lower than expected, particularly in relation to their financial services and technology clients. Despite this short-term disappointment, due to their scale and breadth the business remains well positioned to capture growth from what is a huge global addressable market in digital learning and talent management. The pressure on the share price has been excessive and we used the opportunity to add to our position.

Ergomed, the outsourced provider of clinical development and trial management for the pharmaceutical industry, rose by 38% during the quarter when it was announced that private equity group Premira had bid for the business. There has been a noticeable increase in acquisition interest, within AIM, which is encouraging as it highlights the valuation anomalies and going forward should help buoy the market.

Johnson Service Group rose by 31% during the period, as the workwear and rented linen provider reported a 35% increase in profits compared with 2022. They also announced what should be a significantly accretive acquisition of Celtic Linen which is the largest Healthcare and second largest HORECA (hotels, restaurants and catering) linen supplier in Ireland.

Team Internet (formally CentralNIC) performed well, increasing by 15%. The company is a global wholesale and retail supplier of internet domain names which provides a highly visible and recurring revenue stream. They have been investing in their fast-growing on-line marketing business which is becoming an increasingly important part of the group. They reported strong revenue growth of 31% and declared their expectation of trading at least inline with full year expectations.

Two of the smaller portfolio holdings also performed well during the quarter with Knights group rising 47% and Tribal by 38%, both showing some recovery from recent lows.

Bango was added to the portfolio as a new holding. The company’s payments platform for direct carrier billing (DCB) and digital wallets has grown exponentially from $800m of end user spend (EUS) in 2018, to $8.6bn of EUS at the end of 2022. They have also grown their digital vending machine (DVM) which allows mobile network operator’s customers to pay for digital subscriptions via their mobile phone bill. This provides convenience to end customers and should lower customer churn for the network operators. We believe the shares are considerably undervalued given the growth opportunities ahead for Bango.

Another new holding added to the portfolio was Tristel, a healthcare business specialising in infection control in hospitals. Over 98% of Tristel’s revenues are of repeat consumable products that perform a vital function in hospitals. Given recent and expected regulatory approvals, their growth potential in the ultrasound probe and ophthalmic areas, particularly in North America, is very exciting.

We sold Frontier Developments shortly after the release of their new Formula One management game. Having assessed the reviews and ownership trends of the game, we concluded that sales were likely to disappoint, making the outlook for the business a difficult one.

Following relative strength in Renew, Gamma Communications, Craneware and Young’s we took some profits by trimming the positions. We used these proceeds to add to positions where our investment conviction is high and where we believe companies to be aggressively oversold. The positions we added to were Learning Technologies Group (as mentioned above), Restore, Keywords Studios and Next Fifteen Group.

The portfolio is invested in high quality, structurally growing businesses. Such stocks are perceived to be more interest rate sensitive, hence, this style of investing has been out of favour so far in 2023. However, the growth opportunities for the companies in the portfolio still exist and the current valuation anomaly is attractive. The average price to earnings (P/E) multiple of the portfolio holdings was 25 times at the start of 2022, this has compressed to just 13 times currently. Whilst there is some credence to the interest rate sensitivity argument, there has undoubtedly been other factors at play. Negative momentum has gathered pace and there has been a dearth of buyers in the market. Ultimately, catalysts will emerge, and the true, intrinsic value of the portfolio holdings will be recognised by the market. It is for these reasons that we look to the future with confidence.

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