Spotlight - March 2020
In this month’s Spotlight, we talk about some things that everyone is talking about and some things that few people are talking about
These are testing times. Not just in the general sense that they are difficult, but in the more particular one that they are testing us.
There’s so much to do, from coronavirus contingency planning to explaining what’s happening in markets to clients. There’s the usual flurry of the tax-year end and, on top of that, the government gave us a Budget to think about this week.
But the testing I’m thinking of is more on a psychological level. What is the correct response to a market meltdown induced by a new form of flu that poses grave risks to the economy as well as our health?
I’ve seen the full spectrum of responses in the last few weeks – I’m sure you have too. On the one hand you have total complacency, on the other total panic. And everything in between – anxiety, frustration, denial, neurosis, gallows humour. I’ve certainly seen enough to know that effect of the virus on people’s mental health – while unlikely to be fatal – could be significantly detrimental.
One of the challenges is dealing with other people’s responses. Human nature being what it is, it’s highly likely that these will seem less measured and reasonable than our own. But this virus is likely to impact people in different ways, medically, economically, psychologically. My reasonable could be your complacent.
The market’s disturbing downward lurches provoke similar dilemmas. It’s all very well for me to talk about buying opportunities, with my 20-year time horizon till retirement. But what if someone is two years away? Hopefully they have a good financial planner, but for some people, that won’t altogether expunge their sense of anxiety as they read about billions being “wiped off” the stock market.
We’re taking a resolutely long-term view in Spotlight – as we always do. In this month’s issue, we look at which investment companies would have made you an “ISA millionaire” had you invested your entire annual ISA limit in each company since 1995. Now I’ll be the first to admit there are downsides to a single-company ISA portfolio, but it is a vivid illustration of the wonder of compounding, not to mention the ability of the investment company structure to power long-term returns. And with the Chancellor increasing annual JISA limits to £9,000 from next year, it seems the Treasury’s love affair with the ISA structure in general has survived another change of government.
We had a trio of UK Smaller Companies managers in our office earlier this week – Jonathan Brown of Invesco Perpetual UK Smaller Companies, Stuart Widdowson of Odyssean Investment Trust, and BlackRock Throgmorton’s Dan Whitestone. Given that they are all investing in the same sector, the three of them could hardly have been more different in their style and approach. All of them, however, found reasons for optimism about the sector amid the worries about coronavirus, the slowdown in the domestic and global economy, and the continuing uncertainty surrounding our trading relationship with the EU.
It’s almost always a good time to be investing in UK smaller companies. Invesco’s Jonathan Brown points out that since 1955, UK small-caps have outperformed their larger cousins about three-quarters of the time. Over the past 65 years, an investment of £1,000 has grown to £1.2 million if invested in the FTSE All-Share, but a much nicer £7.8 million if invested in UK smaller companies, as represented by the Numis Smaller Companies Index. The dynamic companies behind these returns are based all over the country, and government measures to support regional development could create more opportunities for Jonathan, Stuart, Dan and their many competitors.
I’ll leave you with one other thought to ponder on. I don’t often wade into the active-passive debate, as I think it’s best left to academics and zealots. But over the past ten years, the average company in the AIC UK Smaller Companies sector has returned 303% (to 28 February) compared with a return of barely half that (156%) for the FTSE Small Cap index. This is one asset class in which going passive could leave you poorer.
Stay healthy, stay optimistic.
Nick Britton, Head of Intermediary Communications, AIC
Upcoming events around the UK
Investment trust workshops
Providing a comprehensive introduction to investment trusts in a friendly and practical way, the AIC’s two-hour workshops have been very highly rated by previous attendees. We are visiting 15 locations around the UK and you can book here.
Wednesday 22 April 2020, 14:00-16:15 – Brighton (Hilton Brighton Metropole, Kings Road, Brighton BN1 2FU)
Thursday 23 April 2020, 14:00-16:15 – Tunbridge Wells (The Spa Hotel, Mount Ephraim, Tunbridge Wells, Kent TN4 8XJ)
Wednesday 29 April 2020, 9:45-12:00 – Chelmsford (The Ivy Hill Hotel, Writtle Road, Margaretting, Chelmsford, Essex CM4 0EH)
Thursday 30 April 2020, 9:15-11:30 – London (The AIC Offices, 9th Floor, 24 Chiswell Street, London EC1Y 4YY)
Tuesday 5 May 2020, 14:00-16:15 – Salisbury (Holiday Inn Salisbury-Stonehenge, Mid-Summer Place, Amesbury, Solstice Park SP4 7SQ)
Wednesday 6 May 2020, 9:45-12:00 – Southampton (Meon Valley Hotel Golf & Country Club, Sandy Lane, Shedfield, Southampton SO32 2HQ)
Thursday 7 May 2020, 14:00-16:15 – London (The AIC Offices, 9th Floor, 24 Chiswell Street, London EC1Y 4YY)
Thursday 14 May 2020, 14:00-16:15 – Cambridge (Hotel Felix, Whitehouse Lane, Huntingdon Road, Girton, Cambridge CV3 0LX)
Tuesday 19 May 2020, 14:00-16:15 – Knutsford (The Cottons Hotel & Spa, Manchester Road, Knutsford WA16 0SU)
Wednesday 20 May 2020, 9:00-11:15 – York (Principal Hotel York, Station Road, York YO24 1AA)
Wednesday 20 May 2020, 14:00-16:15 – Sheffield (Copthorne Hotel Sheffield, Bramall Lane, Sheffield S2 4SU)
Thursday 21 May 2020, 9:45-12:00 – Leicester (Leicester Marriott Hotel, Grove Park, Smith Way, Enderby, Leicester LE19 1SW)
Tuesday 2 June 2020, 14:00-16:15 – Exeter (Mercure Exeter Rougemont Hotel, Queen Street, Exeter EX4 3SP)
Wednesday 3 June 2020, 9:00-11:15 – Bristol (Aztec Hotel & Spa, Aztec West, Almondsbury, Bristol BS32 4TS)
Wednesday 3 June 2020, 14:15-16:30 – Cardiff (Clayton Hotel Cardiff, St Mary Street, Cardiff CF10 1GD)
Thursday 4 June 2020, 9:45-12:00 – Tewkesbury (Hilton Puckrup Hall, Puckrup Lane, Tewkesbury GL20 6EL)
Passing the million mark
The six investment companies that would have made you an ISA millionaire
Despite the recent market falls, new data from the AIC highlights the benefits of long-term investing. Six investment companies would have made investors millionaires if they had invested the annual ISA allowance in the same company each year to the end of February 2020.
Investing the full ISA allowance each year from 1999 to 2019, a total of £226,560, into any of Scottish Mortgage, HgCapital, BlackRock Smaller Companies, Biotech Growth, BlackRock Throgmorton or TR Property and reinvesting dividends would have produced a tax-free pot worth more than £1 million. A full list of the top 20 best-performing investment companies based on annual ISA limit lump sum investments can be found below.
Scottish Mortgage tops the list with a return of £1,109,754, followed by HgCapital with a return of £1,095,066 and BlackRock Smaller Companies with £1,080,199.
A further seven investment companies would have returned over £900,000, more than trebling investors’ total investment.
Of the 20 investment companies with the highest returns, seven are in the UK Smaller Companies sector.
Annabel Brodie-Smith, Communications Director of the AIC, said: “The recent market volatility is understandably concerning for investors. Whilst none of us can be sure of the markets’ next move, it demonstrates the importance of taking a long-term view of your investments. The fact that six investment companies have generated more than a million pounds for those who invested the full ISA limit is a testament to the power of the investment company structure. Seven of the top-performing investment companies are in the UK Smaller Companies sector, investing in smaller, less liquid companies where the structural benefits of the closed-ended structure really come into their own.
“While it’s interesting to see which investment companies would have made investors ISA millionaires, it’s really important to have a balanced portfolio. If investors need guidance on their ISA choices they should speak to a financial adviser.”
Comments from the top three performers
Catharine Flood, Corporate Strategy Director for Scottish Mortgage, said: “In an ever more impatient world, we remain resolutely long term. Scottish Mortgage aims to buy and hold great growth businesses that have the potential to be amongst the few outstanding companies which create the lion’s share of long-term equity market returns, through the power of compounding. Crucial to this is a willingness to endure through the inevitable volatility in stock markets along the way.
“We are delighted to have been able to deliver long-term returns for our shareholders over the last two decades as a result of this patient and diligent approach and within our low-cost structure, which has ensured that they have kept more of the returns generated using their capital. Over that time, there has been a profound change in the way people interact, shop for all kinds of goods and consume media. In China there has also been a revolution in the way many access financial services.
“We believe in the coming years returns are likely to continue to go to those businesses best able to embrace progress and to invest in their own future. The managers anticipate that still more of the global population will access an increasing range of goods and services through mobile digital platforms. There are even greater opportunities from better business models to drive efficiencies in transportation, manufacturing, and even the ways in which we produce and distribute food. Scottish Mortgage remains best suited for those who share our patient approach.”
Matthew Brockman, Managing Partner at Hg, said: “Hg is proud of the performance that HgCapital Trust has seen over more than 25 years as its manager. We are committed to building businesses that change the way we all do business, through deep sector specialisation and dedicated operational support. Hg has a clear investment approach, targeting software and services companies operating in Hg’s eight core end markets, growing faster than the broader economy.
“In 2019, we have reinforced Hg’s focus and scale. Focus on the software and service universe and scale to ensure our reach, expertise and network goes broader and deeper than ever before. Today Hg looks less like a traditional private equity firm and more like a fully collaborative software and services organisation. This is our vision for the future of private equity. We believe our investment strategy works and, with a portfolio of more than 30 companies seeing strong growth, will continue to create long-term value for shareholders in HgCapital Trust.”
Roland Arnold, Portfolio Manager of BlackRock Smaller Companies, said: “Our focus is always on companies and their fundamentals, and we believe this has been key to the success of the trust over the years. We try to identify companies with good long-term growth prospects over the next five to ten years – those companies with earnings momentum resulting from their market position or pricing power. Longer term, the earnings growth of these companies will compensate investors for any shorter-term headwinds. Therefore, we focus far more on the long-term prospects for the companies in our portfolio rather than short-term macro factors.
“We look for five key criteria in an investment – a strong balance sheet, cash flow generation, a strong management team, a decent track record of business growth and a leading market position. That might sound very simplistic – the reverse would be a financially weak business run by rogues – but it’s amazing how much a company can underperform if you stray from these five criteria. We like low capital employed, high return on capital businesses because they can fund their own growth and grow their dividend stream.”
Top 20 investment companies based on annual ISA limit lump sum investments. Source: AIC/Morningstar. Performance is share price total return to 29 February 2020 if the maximum ISA limit for each year had been invested on 6 April in each company annually from 1999 to 2019.
Levelling the field
How the government’s “levelling up” initiative could impact UK companies
Following his landslide election victory in December, Boris Johnson announced plans for significant government spending in regions around the UK including the North, the Midlands and Wales. The plans aim to reduce inequality and boost jobs and growth.
The AIC has spoken to investment company managers about the regional businesses they are backing, the benefits these companies bring to their local areas and the advantages of investing outside London and the South East.
Annabel Brodie-Smith, Communications Director of the Association of Investment Companies (AIC), said: “In this Budget we are expecting greater detail on the proposals to support investment in local areas and economies. The investment company industry offers a range of sectors including UK Smaller Companies and VCTs which can provide investors with access to dynamic regional businesses. This investment delivers growth and social benefits to local economies, where development is most needed.”
Investing outside London and the South East
Laura Foll, Co-Manager of Lowland Investment Company, said: “We own many excellent businesses based outside London including Epwin which is based in Telford, Churchill China based in Stoke on Trent, and Anexo based in Liverpool, to name a few. Our investment process is based on meeting the management and, if we think it will be helpful, visiting companies in situ. Smaller companies based outside London and the South East are often less well known but we believe this presents an opportunity to find good businesses on attractive valuations that meet our investment criteria and may potentially be overlooked.”
Harry Nimmo, Portfolio Manager of Standard Life UK Smaller Companies Trust, said: “Smaller companies are located throughout the UK and, as a manager, geography is irrelevant to me. My focus is on identifying and investing in good quality companies wherever they’re based. One sector that is a great example of this is video gaming. Companies in this space include Team 17, who are based in Wakefield and Nottingham, and Sumo Digital whose HQ is near Sheffield. These businesses were founded in the region and this allows them to access excellent talent, particularly graduates from Sheffield Hallam University which has a well-regarded degree in game design and development.
“A big attraction of working and living outside of London is lower living costs. This combined with an increasing desire for the right work-life balance means talent is no longer moving to London. Smaller companies, in particular, can capitalise on this.
“We’ve seen more small-cap opportunities in Manchester. Companies with a heavy presence there include Autotrader, On The Beach and Boohoo. Of particular benefit to these businesses is the fantastic pool of talent in the area, once again aided by the universities nearby. Manchester is an excellent place to live and has a lot to offer. HS2 and further infrastructure developments could be helpful in making these regions even more accessible.”
Judith MacKenzie, Manager of Downing Strategic Micro-Cap Investment Trust, said: “We don’t actively look to invest inside or outside of London and several companies in the Downing Strategic Micro-Cap Investment Trust have their HQs away from the capital. Our investment process allows us to unearth companies, like Real Good Food in Liverpool, up and down the country that are not on the radar of most fund managers. They tend not to attract as much attention from investors and they attract very good, skilled and loyal workforces.”
Gervais Williams, Portfolio Manager of Miton UK MicroCap Trust, said: “Local champions across all the regions of the UK can be listed, not only offering a route to raise additional risk capital to fund additional employment, local growth and extra tax take, but also offering valuable diversification benefits to savers, at a time when this is more limited elsewhere.”
How could proposed government spending affect smaller UK businesses?
Judith MacKenzie, Manager of Downing Strategic Micro-Cap Investment Trust, said: “We welcome any initiatives that assist smaller companies to grow. A development strategy that covers a wide range of factors that positively help the performance of local businesses is a real positive for the sector. R&D tax credits and regional matched funding really helps promote job creation in areas outside London.”
Laura Foll, Co-Manager of Lowland Investment Company, said: “Some of the companies we hold will benefit from the process of regional economic development. For example we hold contractors, such as Balfour Beatty, that will benefit from infrastructure spending and another company called Hill & Smith which benefits from road building as it makes crash barriers and road signs, as well as carrying out rail station extensions and improvements. Additionally, other companies we hold should benefit from the outcome of regional economic development. For instance, better-connected towns and cities mean you can recruit people from a wider area, while we’ve seen businesses moving out of the South East to towns and cities in the North that often offer much better value in terms of rents and total property costs.”
How are your regional investments helping their local areas?
Gervais Williams, Portfolio Manager of Miton UK MicroCap Trust, said: “Kromek has invested progressively over recent years, and is now being recognised as one of the global leaders in the critical components for medical imaging, or radiation security. Importantly, as this capital expenditure matures, the company won’t just deliver attractive returns for savers, but it has also built skilled employment in Durham from two employees initially, to over 100 now. Alongside that it has boosted domestic growth in the North of England, and in time it will deliver additional tax take for the government as well. In short, well-targeted investment like this is socially useful. It delivers for savers as well as those in and around the Durham area.”
Judith MacKenzie, Manager of Downing Strategic Micro-Cap Investment Trust, said: “Real Good Food has a long association with Liverpool and its Renshaw factory has been a major employer in the city for many years. It has a workforce of around 350 people across four locations. The company offers employment opportunities in many aspects of food processing and manufacturing, logistics and distribution, technical, new product development, commercial and finance. The development activities of the company serve as a global hub for food technologists and scientists, bakers and other creatives working in the food industry.”
Laura Foll, Co-Manager of Lowland Investment Company, said: “One of the holdings in Lowland Investment Company’s portfolio is Palace Capital, a regional property owner in the UK that invests in office, leisure and industrial properties in cities such as York, Newcastle and Manchester. The largest development they are currently undertaking is a project near the railway station in York which will be a mixed-use residential and office space due to be complete in 2021. York has had little new development within the city centre, and this brings high-quality residential space and office space, which has been in high demand.”
Post-Woodford, post-Brexit, where next for the UK Smaller Companies sector?
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 Stuart Widdowson, Odyssean 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.”