Compass - March 2020
We look at smaller companies and advisers give their recommendations for various stages of life
By Annabel Brodie-Smith
Well, it’s been quite a week… The bears are growling, with markets heading south due to the impact of the coronavirus and an oil price war kicking off. Contingency plans for us to work from home are being refined in case of travel restrictions. Most annoyingly but not surprisingly, my husband’s fiftieth birthday trip to Venice at the beginning of April is now definitely off. I’m pleased to say I have got a full refund so that’s a small consolation in a rather miserable week.
We are currently drinking tea, keeping calm and carrying on. Experienced investors know that stressed markets often offer good buying opportunities. Of course, none of us know what markets will do next but taking a long-term view of your investments is crucial. Personally, I’m a big fan of regular investing as it saves me having to decide when is the right time to invest. I just carry on investing come hell or high water. It’s also worth remembering that investment companies have more than 150 years of heritage and have survived World War I, World War II, the Great Depression and the Financial Crisis.
This week I have been talking to UK Smaller Companies managers about the impact of coronavirus, post-Brexit Britain and a lot more. Over ten years to the end of February, UK smaller companies was one of best-performing investment company sectors up 303%. To market close on 12th March the UK smaller companies sector was up 232% over ten years. The discount to the asset value was 7%, widening from 3% at the end of December. Despite the market falls, the managers remain confident of smaller companies’ ability to outperform over the long term and some even have some cash ready to invest at some stage. To find out more watch the videos of Stuart Widdowson, Co-Manager of Odyssean Investment Trust and Jonathan Brown, Co-Manager of Invesco Perpetual UK Smaller Companies. The views of these managers alongside Dan Whitestone of BlackRock Throgmorton and Charles Montanaro of Montanaro UK Smaller Companies, are all collated in our article.
Our investment expert, Ian Cowie is also diving into smaller companies this month. He has sadly missed out on the UK smaller company success stories but has been investing in Japanese smaller companies and has a new holding in JPMorgan Japanese Smaller Companies.
Interview with Jonathan Brown, Invesco Perpetual UK Smaller Companies Investment Trust
Interview with Stuart Widdowson, Odyssean Investment Trust
Finally, it’s ISA season and a tax-free £20,000 investment is not to be missed out on. We have asked three financial advisers to put together their ISA recommendations for millennials, middle-aged and retired investors. There are lots of well-known companies you might know like Scottish Mortgage and F&C Investment Trust, as well as the more unusual and ‘zeitgeisty’ Hipgnosis, which purchases songs and receives royalties rights.
Hope everyone keeps smiling and healthy!
See you next month.
Communications Director, AIC
Managers outline smaller company opportunities in a post-Brexit Britain
The UK Smaller Companies sector has been one of the most rewarding for investors over the past decade. The average return from an investment company in the sector over the past ten years is 303% (to end of February 2020), compared to 166% for the average investment company over the same period.
Despite this strong long-term performance, worries remain about the UK’s relationship with its largest trading partner, the EU, not to mention the recent market falls. What does the future hold for smaller companies in post-Brexit Britain and where are managers finding opportunities?
At a media roundtable held by the AIC, Dan Whitestone, Manager of BlackRock Throgmorton Trust, Jonathan Brown, Co-Manager of Invesco Perpetual UK Smaller Companies Investment Trust, and Stuart Widdowson, Co-Manager of Odyssean Investment Trust, discussed their recent investment activity, the effect of the coronavirus on their portfolios and their overall outlook for the sector in post-Brexit Britain. Their thoughts have been put together alongside comments from Charles Montanaro, Manager of Montanaro UK Smaller Companies.
Annabel Brodie-Smith, Communications Director of the AIC, said: “Investors willing to back smaller businesses on home soil have done well over the past decade. An investment in the average investment company in the UK Smaller Companies sector ten years ago would have quadrupled in value. The recent market sell-off is uncomfortable for investors. No-one knows what markets will do next but in the past investors who have kept their faith and remained invested have been well rewarded over the long term.
“This encouraging long-term performance shows that even though investing in smaller companies may carry more risk, it can really pay off over the long term. These rewards are amplified by the closed-ended structure. Given that many smaller companies’ shares can be illiquid, it’s a great advantage not to have to sell them into market downturns. Instead, closed-ended fund managers can invest right down to the smallest and least liquid companies in the knowledge that they will not have to sell these holdings before they are ready to do so.”
Have you seen any change in sentiment towards investing in smaller companies post-Woodford?
Charles Montanaro, Manager of Montanaro UK Smaller Companies, said: “The gating of a high-profile fund has brought to attention two things. The first is the dangers of owning illiquid and unquoted assets in an open-ended fund. Certainly this has highlighted the benefits of closed-ended structures which do not have to manage daily investment flows. The second is the risk of fund managers moving away from their area of expertise. We have managed small and mid-cap portfolios for almost 30 years. It is all we have done and all we will ever do.
“Some of our clients wanted reassurance about the underlying liquidity of our funds, which was easy to provide. Debacles such as Woodford are actually positive for boutiques such as Montanaro that take a disciplined and pro-active approach to managing liquidity risk. It is an intrinsic part of what we do.
“Generally, sentiment has not changed much for us. Woodford was not a specialist in small cap and did not have the in-house resources to conduct the required due diligence. The consequences were self-evident and predictable. It shows the importance of working with specialists in smaller companies who have the expertise and know what they are doing.”
Where are you finding opportunities and what risks are you most focused on?
Stuart Widdowson, Co-Manager of Odyssean Investment Trust, said: “Opportunities now are similar to when we launched Odyssean Investment Trust in May 2018 – higher-growth, high-momentum stocks have become, in some cases, very over-valued. The value in the market is more with companies which are not quite firing on all cylinders.”
Jonathan Brown, Co-Manager of Invesco Perpetual UK Smaller Companies Investment Trust, said: “We are adding on a stock-specific basis rather than by sector. Where we can find good quality businesses with growth potential, at sensible valuations, that is always of interest to us. We have recently added to cyber security business NCC, UK estate agent LSL Property and Midwich, which is an audio-visual equipment distributor.
“We see risk around valuation in some of the popular momentum growth stocks and have been taking profit in some of those names and reinvesting it in more modestly valued businesses.”
Interview with Jonathan Brown, Invesco Perpetual UK Smaller Companies Investment Trust
Dan Whitestone, Manager of BlackRock Throgmorton Trust, said: “The main attraction of the universe of small and medium sized companies is the abundance of opportunities and the excitement of trying to uncover the next leader of the future. This might centre around a company with a differentiated product or business model that requires little capital to grow and has a small market share in a large and growing fragmented space - 4imprint, YouGov and Integrafin are all good examples.
“However, we also focus on long-term secular growth trends that individual companies are either driving or benefitting from. One such theme is ‘digital transformation’. In our view, this is a multi-year growth trend reflecting the strategic imperative for corporates to invest in their digital capabilities to either drive efficiency or yield improvements. This is a vast but growing industry which shows little signs of slowing.”
What is your outlook for the sector?
Jonathan Brown, Co-Manager of Invesco Perpetual UK Smaller Companies Investment Trust, said: “The beauty of small cap is the sheer diversity of opportunity available to investors. We are particularly interested in businesses with self-help characteristics, roll-out potential, sector consolidation plays and companies exposed to higher-growth niches in the economy. We believe these stocks can do well irrespective of the wider economy.”
Charles Montanaro, Manager of Montanaro UK Smaller Companies, said: “Predicting macro developments, such as the future direction of UK trade negotiations, sit outside our sphere of competence and are virtually impossible to predict. Rather, we spend our time meeting and listening to our companies. In our experience, this is where we can begin to understand the true drivers of growth that are so important to the trajectory of long-term investment returns. Whatever the political weather, the UK is home to some truly innovative, world-class businesses. We do not expect this to change and are optimistic about the future of the UK.”
Dan Whitestone, Manager of BlackRock Throgmorton Trust, said: “In our view, the Conservative majority in Parliament with a clear mandate to ‘get Brexit done’ removes tail risk. More clarity should lead to increased business confidence and corporate spending. This has the potential to create a healthy backdrop of improving corporate profitability both for domestic and global facing UK PLCs.
“There is an abundance of interesting growth companies to identify and no industry stands still. We remain alert and vigilant in detecting positive or negative change to our existing investments and also new opportunities. However, we still don’t know what Brexit will look like and there are many hurdles to overcome: trade negotiations may cause further volatility, not only as the UK seeks to renegotiate relationships but also between the US and China. Meanwhile, the recent coronavirus outbreak merits some caution. As a result, we have not made any significant changes to the portfolio at this stage.”
Stuart Widdowson, Co-Manager of Odyssean Investment Trust, said: “It’s difficult to generalise and it depends on what Brexit we end up with. There will always be winners and losers, and companies for which Brexit makes no difference. As an asset class, UK equities probably become more attractive once there is certainty on the nature of Brexit – and smaller companies will do well in that environment. A rational response would be a pick up in the IPO market, which would be welcomed as there has been a steady decline in the number of UK quoted smaller companies since 2000.”
Ian Cowie on why smaller companies make sense for the long term
Stock market shocks caused by the coronavirus and oil price slump hit headlines in the short term but serious investors should remain focused on the medium to long term. For example, smaller companies may not be household names yet but have an impressive history of generating bigger returns.
Investment companies offer a convenient and cost-effective way to gain exposure to this sector, automatically sharing the cost of professional stock selection and providing diversification over dozens of different underlying holdings to diminish the impact of setbacks or failure at any one company.
That’s important because, although it may be easier for a small business to double in size than it is for a large one to do so, not every acorn grows into an oak. Smaller companies tend to be more likely to rely on a single trade or market than large businesses and less likely to have substantial reserves to enable them to survive unexpected adversity.
However, professional fund managers can benefit from extensive experience, including visiting underlying businesses in which they invest, interviewing their senior staff and scrutinising their books. This can help smaller companies fund managers sort the wheat from the chaff for shareholders, picking plums while shunning sour grapes.
Never mind the theory, how has it worked in practice? After recent shocks to global stock markets caused by the coronavirus and oil price drop, the average conventional investment company - that is, excluding venture capital trusts (VCTs), has lost 9% over the last year, gained 27% over the last five years and 123% over the last decade, according to independent statisticians at Morningstar today, March 13th.
The average UK smaller companies investment company has lost 11%, and gained 33% and 232% over the same respective periods. Interestingly, this sector remains competitively-priced with its average share trading at a 7% discount to net asset value (NAV), compared to the industry average for conventional investment companies of all types trading at a discount of 7%.
Sad to say, I haven’t shared in bigger returns from UK smaller companies investment companies recently. My investment in Rights & Issues (RII) last December has not proved profitable so far, shrinking by 11% over the last year, but it is early days yet. Gresham House Strategic (GHS) is the top performer in the sector with a total return of 13% over the last year. The sector leader over the last five years is Rights & Issues with a total return of 104%.
More happily, I have been a shareholder in Baillie Gifford Shin Nippon (BGS), a Japanese smaller companies investment company, for more than a decade during which time it delivered total returns of 303% with 75% over the last five years. Coronavirus fears crushed returns to a loss of 32% over the last year.
Even so, I remain confident about the medium to long-term outlook and recently added another holding in this sector, buying shares in JPMorgan Japan Smaller Companies (JPS) where hopes of growth in future are supplemented by 5.4% dividend income today. Most smaller companies continue to focus on achieving capital gains but some also pay shareholders to be patient with a decent dividend yield.
For example, I also used to be a shareholder in European Assets (EAT), which focuses on smaller companies on the continent and delivers dividend income of 8.8%. Subject to the approval of each investment trust’s board of independent directors, it is possible to pay enhanced dividends by using some capital growth to supplement income payments to shareholders. However, my most successful smaller company investment companies have placed their priority on medium to long-term growth - and not just Shin Nippon in Japan. For example, JPMorgan US Smaller Companies (JUSC) has delivered total returns of 35% and 234% over the last five years and decade; beating the industry-wide averages over both of those periods.
Whether you seek income or growth or a mixture of both, whether your focus is on the largest economy on earth or exposure elsewhere, it’s well worth considering smaller companies for bigger returns.
ISA pick 'n mix
Financial advisers recommend investment companies for different stages of life
As the end of the 2019-20 tax year approaches, time is running out to make the most of your £20,000 annual ISA allowance. Investment companies’ strong long-term performance, income advantages and ability to invest in a wide range of assets make them a compelling option, but with over 300 to choose from where should an investor start?
The AIC has spoken to financial advisers to discover which investment companies they would recommend at three different stages of an investor’s life. Recommendations are included below for millennials, middle-aged and retired investors.
Jim Harrison, Director at Master Adviser, said: “An investment trust which feels zeitgeisty and might appeal to younger investors with a long investment horizon and a taste for something other than vanilla is Hipgnosis. Hipgnosis purchases songs and the associated intellectual property rights, and receives the three streams of royalties: mechanical - when a copy is made, for example a CD or a permanent download; performance - when it is performed live, broadcast or streamed online; and synchronisation - when it is used on TV, or in a video game for example. Like an infrastructure fund, it is mainly a capitalisation of cash flows, although the catalogues and individual songs can be sold on.
“It is not without risk – the music industry has always been vulnerable to having their product distributed for free, and today’s chart topper can quickly fade. Once the income stream from a song dries up, it’s hard to see it holding its capital value. Hipgnosis has a dividend yield of 4.9%, but is trading at a noticeable premium to NAV, so investors might want to wait until this reduces. I wouldn’t put a whole ISA contribution in here, but it could be an interesting diversifier for a portfolio.”
Philippa Maffioli, Senior Adviser at Blyth-Richmond Investment Managers, said: “For a young person starting their investment journey, I am very keen on recommending that they invest in a couple of investment trusts on a monthly basis (or as a lump sum, depending on their circumstances) in order to benefit from pound-cost averaging. Scottish Mortgage is a large, low-cost investment trust which is actively managed by James Anderson and Tom Slater. It has global exposure and the managers look for strong, well-run businesses which offer the best potential and durable growth opportunities for the future.
“I believe that it is important for young people to have exposure to small and mid-cap companies in order to benefit from long-term capital growth. I therefore recommend Blackrock Throgmorton which is managed by Dan Whitestone whose speciality is constructing a well-diversified portfolio and I believe that this trust should be the bedrock of a young person’s portfolio.”
Paul Chilver, Associate and Financial Planning Manager at Birkett Long, said: “Generally speaking younger clients have a longer investment time horizon and can withstand stock market volatility. Therefore, they can accept a greater degree of risk and two investment trusts managed by Baillie Gifford offer potential long-term growth. Pacific Horizon invests in the Asia Pacific region and is currently at a potentially attractive discount of circa 7%. It provides diversity across the Asia Pacific region. Edinburgh Worldwide sits in the Global Smaller Companies sector and invests with a view for long-term capital growth and is a good option for investors with a longer-term objective.”
Philippa Maffioli, Senior Adviser at Blyth-Richmond Investment Managers, said: “I recommend JPMorgan Claverhouse to middle-aged investors because of its strong dividend growth, whilst also allowing investors to benefit from capital appreciation. It is good for relatively young retirees because they can benefit from the yield of 4.4% as well as capital growth which makes it a good long-term holding.
“I have been recommending F&C Investment Trust for over 20 years. Due to its pedigree and the ongoing commitment of the management, I believe it is an essential component of everyone’s portfolio regardless of stage in life. I am keen to see it in a middle-aged person’s portfolio because of its sheer size and resulting diversity. With its potential for capital growth and modest dividend, it is good for retirement, saving for school fees and leaving a legacy.”
Paul Chilver, Associate & Financial Planning Manager at Birkett Long, said: “An attractive equity region which has generally been out of favour in recent years is Europe. I suggest there are two investment trusts to consider for investment – Fidelity European Values and BlackRock Greater Europe. Both companies historically have had a strong European equity offering. In addition, both trusts have an all-cap investment approach and are currently trading at a discount.”
Jim Harrison, Director at Master Adviser, said: “A middle-aged investor is likely to have a long time to go to retirement, but ought to have an eye on how they might replace their earned income when they do retire.
“Growth stocks have been in the ascendancy for the past few years, though we have seen signs of that changing; investors with a long horizon would do well to consider Temple Bar, run by the veteran avoider of ninja-grannies, Alastair Mundy.
“A dividend hero of 36 years, with a yield of 4.5% and a five-year dividend growth rate of 5.7%, Temple Bar will spend potentially lengthy periods where the share price suffers, but Mundy pays you handsomely to wait. If the dividend growth rate is maintained, it’s more than possible that by the time you come to retire your yield-to-cost is high enough for you to disregard the day-to-day fluctuations of the share price.”
Paul Chilver, Associate & Financial Planning Manager at Birkett Long, said: “Retirees are more likely to require an income from an investment and with that in mind a suggestion would be Temple Bar managed by Investec’s Alastair Mundy who is known for his contrarian investment approach which has been out of favour in recent years. However, having this value bias means that the investment will provide diversification to an individual’s portfolio and it is currently paying a dividend of over 4% per annum. With a slightly lower dividend yield of 2.1%, Finsbury Growth & Income is another good option for a retiree and its investment approach would blend nicely with Temple Bar.”
Jim Harrison, Director at Master Adviser, said: “There will be various requirements for a retirement investor, but a main one is likely to be the need for an immediate income as a salary replacement. A key component of this should be Simon Gergel’s Merchants. The objective is a higher than average yield with long-term capital growth. The current yield is around 5.8%, partly thanks to the recent fall in capital values across the market, and that looks like a steal for a predominantly blue-chip portfolio. The dividend growth rate is modest, 2% a year over the last five years, and this is the price investors pay for the higher starting yield. Combined with a trust which starts with a lower yield and grows, for example Lowland, investors could easily get the best of both worlds.”
Philippa Maffioli, Senior Adviser at Blyth-Richmond Investment Managers, said: “Henderson International Income is vital within a retiree’s portfolio due to its attractive dividend yield of around 4.0%. Ben Lofthouse is a well-regarded fund manager, whose aim is to provide diversification for investors who already have plenty of UK equity income exposure and therefore require international income exposure.
“Dunedin Income Growth is essential for an income-hungry retiree. It contains a selection of high-quality UK and overseas companies, delivering a resilient quarterly income. It is managed by Louise Kernohan and Ben Ritchie and currently has a yield of 4.6%. Dividends are paid in February, May, August and November, which is good for providing smooth dividend flows within a portfolio.”