Small caps flying high
Trusts in the UK smaller companies sector have enjoyed a cracking year, with average share price gains of 44%.
This compares with gains of 32% from the FTSE Small Cap index and 43% from the Hoare Govett Smaller Companies (HGSC) index, which is the more popular trust benchmark.
Despite its good run, the sector's average discount is 16% compared with 9% in the UK growth sector. This might imply that, despite their greatly superior long-term returns, smaller company trusts have a less than rosy future. However, trust managers disagree.
For example, gearing on Aberforth Smaller Companies Trust, the sector giant, is well above its long-term average, indicating that its value-oriented managers are confident that smaller companies are cheap and have plenty of room to grow in value.
Standard Life UK Smaller Companies Trust has trounced its sector peers since Harry Nimmo took charge in 2003.
He focuses on companies with strong balance sheets and resilient business models. Overseas exposure accounts for around half of his portfolio's combined earnings.
Nimmo says smaller companies usually do well for 18 months after a turn in the market, which explains why his trust is still 11% geared.
Gartmore Growth Opportunities has the best three-year performance figures, which were boosted by a large put option on the FTSE 100 index, which it exercised in October 2008.
Manager Gervais Williams says smaller companies are undeservedly under-owned by institutional investors, who are ignoring superior growth potential derived from starting from a smaller base.
Added attractions include the dividend growth prospects of some smaller companies, the increased potential for rewarding takeovers when sterling is weak and the fantastic scope for good sharepickers in such a large universe.
Spotlight on Throgmorton Trust
Throgmorton trust is very different to its peers. It has a traditional long-only portfolio managed by Mike Prentis, similar to its stablemate BlackRock Smaller Companies, which Prentis also manages.
Prentis expects smaller companies to continue to outperform, as the rise in their share prices has been justified by the recovery in profits. He is keen on companies focused on faster-growing regions. Half of his revenue comes from Asia and North America.
He concentrates on around 150 promising holdings in a universe of more than 1,500 companies. "Many are leaders in their sectors and managed to cut costs and grow their market share in the downturn," he says.
"Around a fifth is in companies capitalised at less than £100 million, as they are under-researched and can be very exciting over the long term."
Prentis says the CFD portfolio added to returns in last year's rapidly rising market but should do even better in more stable conditions, as it is easier to make money from taking short as well as long positions in underlying securities.
It should also prove its worth if markets plummet, as it can reduce Throgmorton's net exposure to 70%.
Jonathan Ruck Keene, head of investment companies at BlackRock, says Throgmorton's unique structure is attracting a following among private client stockbrokers.
However, they dislike its commitment to regularly offer to buy back shares at a discount well below the average for the sector, as they feel obliged to subscribe.
The trust proposes to suspend these tenders following a final offer of up to 25% for investors who want to get out.
This article was originally published in Money Observer - Moneywise's sister publication - in June 2010
Investors who borrow money they use for investment and use the securities they buy as collateral for the loan are said to be “gearing up” the portfolio (in the US, gearing is referred to as “leveraging”) and widely used by investment trusts. The greater the gearing as a proportion of the overall portfolio, the greater the potential for profit or loss. If markets rise in value, the investor can pay back the loan and retain the profit but if markets fall, the investor may not be able to cover the borrowing and interest costs, and will make a loss. Also used to describe the ratio of a company’s borrowing in relation to its market capitalisation and the gearing ratio measures the extent to which a company is funded by debt. A company with high gearing is more vulnerable to downturns in the business cycle because the company must continue to service its debt regardless of how bad sales are.
All investment returns are measured against a benchmark to represent “the market” and an investment that performs better than the benchmark is said to have outperformed the market. An active managed fund will seek to outperform a relevant index through superior selection of investments (unlike a tracker fund which can never outperform the market). Outperform is also an investment analyst’s recommendation, meaning that a specific share is expected to perform better than its peers in the market.
An individual employed by an institution to manage an investment fund (unit trust, investment trust, pension fund or hedge fund) to meet pre-determined objectives (usually to generate capital growth or maximise income) in prescribed geographic areas or investment sectors (such as UK smaller companies, technology or commodities). The manager also carries the responsibility for general fund supervision, as well as monitoring the daily trading activity and also developing investment strategies to manage the risk profile of the fund.
If you own shares in a company, you’re entitled to a slice of the profits and these are paid as dividends on top of any capital growth in the shares’ value. The amount of the dividend is down to the board of directors (who can decide not to pay a dividend and reinvest any profits in the company) and they will be paid twice yearly (announced at the AGM and six months later as an interim). Dividends are always declared as a sum of money rather than a percentage of the share’s price. Although dividends automatically receive a 10% tax credit from HM Revenue & Customs (HMRC), which takes the company having already paid corporation tax on its profits into account. Dividends are classed as income and, as such, are liable for personal taxation and so shareholders have to declare them to HMRC.
A complicated financial instrument, Contracts for difference are a specific type of derivative. They were developed to allow the capital benefits of investing in an asset without actually physically having to own or pay full price for it. A CFD is a contract between a buyer and seller, stipulating the buyer will pay to the seller the difference between the current value of an asset (share, bond, commodity, index) and its value at contract time. If the difference is negative, then the seller pays the buyer).
A standard by which something is measured, usually the performance of investment funds against a specified index, such as the FTSE All-Share. Active fund managers look to outperform their benchmark index. Cautious fund managers aim to hold roughly the same proportion of each constituent as the benchmark, while a manager who deviates away from investing in the benchmark index’s constituents has a better chance of outperforming (or underperforming) the index.
A market-weighted index of the 100 biggest companies by market capitalisation listed on the London Stock Exchange. It is often referred to as “The Footsie”. The index began on 3 January 1984 with a base level of 1000; the highest value reached to date is 6950.6, on 30 December 1999. The index is “weighted” by how the movements of each of the 100 constituents affect the index, so larger companies make more of a difference to the index than smaller ones. To ensure it is a true and accurate representation of the most highly capitalised companies in the UK, just like football’s Premier League, every three months the FTSE 100 “relegates” the bottom three companies in the 100 whose market capitalisation has fallen and “promotes” to the index the three companies whose market capitalisation has grown sufficiently to warrant inclusion. Around 80% of the companies listed on the London Stock Exchange are included in the FTSE 100.