Go small to win big
Ian Cowie on the joys and pains of smaller company investing
Small companies can generate big returns for investors willing to accept risks – which can be summarised with the observation that not every acorn grows into an oak.
The danger of capital loss among corporate tiddlers tends to be greater because smaller businesses are less likely to have diversified revenues or substantial reserves against unexpected setbacks. Put more positively, it may be easier for nimble, smaller companies to double profits and share prices than it is for bureaucratic, bigger rivals.
“…it may be easier for nimble, smaller companies to double profits and share prices than it is for bureaucratic, bigger rivals."
Investment trusts provide the ideal way to navigate the potential risks and rewards at this end of the market. In addition to diversification – or spreading our money over dozens of different companies, to reduce our exposure to shocks at any one of them – professional stock selection can prove most valuable among businesses that are not yet household names or familiar to this individual investor.
That's especially true overseas where I am a long-term shareholder in Baillie Gifford Shin Nippon (stock market ticker: BGS), Edinburgh Worldwide (EWI), European Assets Trust (EAT), India Capital Growth (IGC) and JPMorgan US Smaller Companies (JUSC). Most topically, small and medium-sized businesses might prove less vulnerable to global trade wars, triggered by tit-for-tat tariffs or taxes on imports, because these businesses tend to focus on their domestic markets rather than seek international revenues from exports.
Sad to say, that has not entirely insulated this small investor from fluctuations in financial fashion. Baillie Gifford Shin Nippon, where I have been a shareholder for more than a decade, has suffered recently from doubts about the fund managers’ focus on growth and, more generally, the Japanese economy.
Both headwinds hurt, reducing total returns to 83% over the last decade and shrinking shareholders’ capital by 34% over the last five years and 6% over the last year, according to independent statisticians Morningstar. Well, you can’t say I only talk about my winners. However, ongoing charges of 0.72% remain reasonable, so I have no intention of selling and intend to continue holding for the long term.
Edinburgh Worldwide is enjoying stratospheric returns from having 12% of its £852m assets invested in the rockets and satellites business, Space Exploration Technologies. While SpaceX is not listed on any stock market, this investment trust is one of the few ways ordinary shareholders can invest alongside billionaires such as Elon Musk.
“While SpaceX is not listed on any stock market, this investment trust is one of the few ways ordinary shareholders can invest alongside billionaires such as Elon Musk.”
Other interesting underlying assets include the drone-maker, AeroVironment, and the body camera-maker, Axon Enterprise. The latter is one of the first businesses to use artificial intelligence (AI) to cut the time taken to transcribe police interviews. What it all boils down to for Edinburgh Worldwide shareholders are total returns of 137% over the last decade, minus 9% over five years and – as if to demonstrate volatility in this sector – 34% over the last year. Once again, ongoing charges are reasonable for such specialist exposure at 0.76%.
European Assets is the outlier in my smaller companies investment trusts portfolio because it yields an inflation-busting 6.5% dividend income. Unfortunately, the Continent’s worst war since 1945 has not helped total returns over the standard three periods of 62%, 12% and 5%.
India Capital Growth pays no dividends but delivered total returns of 155% and 136% before shrinking by 7% last year. However, partly because India was the home of my very first ten-bagger or share whose price went up by more than ten times (which, since you ask, was called Fleming Indian when I invested in 1996 and now trades as JPMorgan Indian) I remain optimistic about the world’s largest democracy.
Returning to the world’s largest economy, JPMorgan US Smaller Companies is benefiting as shares in its underlying holdings begin to catch up with bigger rivals in the ‘Magnificent Seven’ technology stocks. This investment trust achieved total returns of 194%, 43% and 29% over the usual three periods.
For anyone wondering why I don’t currently have any exposure to the UK Smaller Companies investment trust sector, I should explain that this is a historical accident, based on earlier investments in British tiddlers including Fevertree Drinks and ITM Power. Both went up like rockets before coming down like sticks but continue to satisfy the UK element in this small shareholder’s desire to build a diversified portfolio of global assets.
The dramatic ascent, followed by shocking declines, of these two stocks also demonstrates how buying individual shares is much riskier than investing internationally via smaller companies investment trusts. From modest beginnings, great things can grow.
Ian Cowie is taking part in the AIC’s fantasy fund manager competition. You can catch up on the progress of his virtual portfolio in our January update.
