Boutique fund manager Milkwood Capital has blocked the wind-down of Downing Strategic Micro-Cap (DSM ) with the aim of taking over the distressed UK smaller companies fund and making good shareholders’ losses of over 40% from the past seven years.

Milkwood, a 10-year-old Windsor-based company that describes itself as a ‘fundamental valuation-driven asset manager’, became the largest shareholder in the investment trust after buying a 28% stake last month. 

Founder Rhys Summerton wants to relaunch the listed fund and continue its remit of engaged investing in a concentrated pool of UK small-cap stocks. In an interview with Citywire he cited the example of sector leader Rockwood Strategic (RKW ) whose 164% five-year returns he would rather emulate than the 16% decline in DSM over that period.

Summerton (below), a Zimbabwean, former sell-side analyst who sits on the board of Israeli advertising agency Nexxen (NEXN), said he ran the Milkwood Fund, a £150m Cayman Islands long-short fund 90% invested in the UK.

Big performance claim

In a letter to DSM’s board earlier this year, he claimed the UK assets of Milkwood Fund had generated a 137% return in the three years to the end of 2023, beating all existing micro-cap funds, including 83.1% from Rockwood and 0.7% from DSM.

He said Milkwood would not a charge a management fee until it had restored DSM shareholders’ losses by returning the share price to 100p.

On Wednesday Summerton used Milkwood’s holding to vote against a return of capital that would have seen DSM begin to pay out the 40% cash accumulated in the portfolio after a series of disposals following the company’s decision to wind down last year.

As a result, a special resolution that would have seen DSM issue and then cancel new B-shares, as a way of distributing the money, received the support of 56.65% of votes, short of the 75% required to pass.

The company has a market value of just £27m and net assets of £30m after Downing’s former star fund manager Judith MacKenzie lost its original shareholders over 40% of their capital.

From a launch at 100p in May 2017, the shares have fallen to 57p at a 9% discount to net asset value, although they have recovered from a Covid-crash low of 42p in 2020.

DSM announced its intention for a managed wind-down last November, a move that 86% of shareholders backed in a vote in February.

Chair Hugh Aldous said the B-share scheme was the most tax-efficient way to return capital and the board would now press ahead with two special dividends to fulfill its mandate from shareholders to wind down the closed-end fund.

It declared the first special of 30p per share, which will pay out nearly £14m, followed by a second distribution of at least £3.7m.

Cash exit dispute

Noting that the ‘new’ shareholder was ‘seeking to secure the future management of the company’s portfolio for itself’, Aldous said it compromised shareholders who had voted for the wind-down because Milkwood had not offered a cash exit.

Summerton denied this, telling Citywire his proposals to turn around the trust, which he sent to Aldous in January, agreed to a tender offer that would have seen the company buy back some shares from shareholders who did not want to stay under his management.

He said the voting figures were largely representational of institutional shareholders, claiming many private investors didn’t vote at the meetings.

‘Our interest is purely to bring life into this carcass, which Downing has created with seven years of underperformance, losing 40% of the original investment. We gave the board a proposal to show where we’re coming from - we would manage the fund for free because we wanted to show the poor investors, who are going to lose a further 15% of their investment with the special dividend, that there’s a path to recovering their capital,’ Summerton said.

‘Dispiriting’ period

In the recent half-year results, chair Hugh Aldous described the past few years as ‘dispiriting’ for UK micro-caps, leading to the board’s ‘blunt decision’ to return capital earlier than expected. He anticipated paying out half its market value by June if bids for some holdings completed in time.

Milkwood bought its holding from the Foresight-owned Thames Venture Fund 2 and EQ Investors, both of whom had previously backed the trust’s folding.

If Summerton succeeds in taking over DSM, he plans to invest in about 12 stocks but would slightly relax its micro-cap focus by backing companies at around the £150m level in order to improve liquidity. He said it would also invest in private, unquoted companies when their valuations become more attractive than listed ones. 

Summerton wants to grow the sub-scale trust, bringing across some of Milkwood’s existing investors and hoping to attract new investors through improved performance.

‘Why would somebody want to shut a perfectly good structure, a fund that is being forced to sell shares at the bottom of the market?’, he said, adding that investment trusts were the ‘perfect’ way to invest in the UK equity market.