Strategic Eqty Share Price (SEC)

Peer group comparison The 11 UK smaller cap investment companies that make up the peer group below encompass a range of divergent investment styles and SEC’s investment approach is unique within the peer group. SEC ranks tenth of 11 funds over one year. The principal reason for this may be SEC’s weighting to ‘smaller small caps’ and AIM companies, which, as we noted on page 7, underperformed FTSE small cap ex-IC stocks in 2012. SEC’s analysis of performance in Q412 highlights falling share prices for KCOM (disappointing results), Lavendon (which SEC believes may be shorted by hedge funds) and Tyman (on profit taking); these three stocks reduced the NAV by 2% over that period. SEC is sixth of 11 funds over three years and tenth of 11 over five years in terms of total shareholder return. SEC’s ongoing charges are the second-highest of the peer group and its discount is the second-widest. It is among the lowest-yielding UK smaller company funds.

Dividend policy and record The directors expect shareholder returns will derive primarily from capital appreciation and intend only to declare final dividends to the extent necessary to maintain SEC’s investment trust status (not retaining more than 15% of income). SEC did not declare a dividend in two of the seven accounting periods since launch. The dividend for the period ended 30 June 2012 was substantially higher than for the previous year and the highest paid since launch, but this should not be taken as any indication of likely future dividend payments.

There are 64.6m ordinary shares in issue and no other classes of share capital. Borrowing 25% of net assets is permitted, but a £5m loan facility with RBS expired in July 2012, and the board decided not to renew it since it was not being used. Ongoing charges for the year ended 30 June 2012 were 1.3% (2011: 1.5%). The management fee is the lower of 1.0% of the adjusted NAV of the company and 1.0% pa of the company’s market capitalisation (to prevent double counting, the holding in SRF II is excluded from the calculation). There is a performance fee of 15% of the outperformance of the FTSE Small Cap ex-IC Index plus 2% pa, with a high-water mark. The performance fee is capped at 1.75% of NAV, with the excess that is deferred to future periods payable if that period’s cap has not been exceeded and the NAV is still above the high-water mark. Shareholders can vote on whether the fund should continue as an investment trust at each AGM.

As a means of controlling the discount, the board has instituted a series of semi-annual tenders for 4% of the issued share capital at a 10% discount. The first of these tenders took place in May 2012 and the two held to date have both been oversubscribed. The discount briefly widened to c 25% in September 2012, but has narrowed since and is now around 18.5%, in line with its average over the past year. SEC has powers to buy back 14.99% of its share capital, renewed annually at the AGM, but outside of the tenders, it has not bought back stock since June 2011.

Recent performance SEC’s concentrated portfolio and the managers’ emphasis on bottom-up fundamental research suggest stock selection will usually have the greatest impact on SEC’s performance. Recent performance has been good in absolute terms (in line with SEC’s investment objective), but poor relative to the FTSE Small Cap Index ex-IC and those investment companies that specialise in investment in UK smaller companies. On balance, larger stocks and fully listed stocks outperformed other small caps in 2012. The AIM market, which is about one-third of SEC’s portfolio, fell by 1.6%, while the FTSE Small Cap Index ex-IC rose by 35.8% in 2012. This may have inhibited SEC’s performance. The managers also believe Q412 saw a good performance from high-indebted, low-margin companies, stocks that are generally not present in SEC’s portfolio.

Current portfolio positioning While the investment strategy places no emphasis on monitoring weights relative to any benchmark, it may be interesting to note that relative to the UK market, the portfolio has a significant bias to industrials and is very underweight in a range of sectors, notably oil and gas, financials and consumer goods. This does mean performance diverges significantly from that of the market. The managers have been deploying some of the cash in the portfolio, topping up holdings in E2V after its share price fell in October, Goals Soccer Centres (taking SEC’s stake in that company over 5%) and Gooch & Housego.