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Tuesday, 30th June 2020 14:13 - by David Harbage
Following the review of a ‘Magnificent Seven’ (famous fund managers), this blog highlights two of the author’s favourite funds that focus on stock exchange listed UK firms outside of the FTSE100 index. Believing that smaller can be more nimble in the world of business, this market segment holds greatest appeal to the writer who views these firms’ business models as being more interesting and their management often more candid about their prospects.
JP Morgan Smaller Companies investment trust, managed by Georgina Brittain and Katen Patel, aims to invest in UK smaller companies to provide capital growth via outperformance of the Numis Smaller Companies index. Over the past 1, 3, 5 and 10 years to 31 March 2020 the shares have delivered a total (income, plus capital appreciation) annualised return of +6.1%, +8.4%, +8.9% and +14.5% (as compared to the benchmark’s -12.1%, -4.5%, +1.6% and +9.0%) respectively. The current portfolio features overweight – compared to the Numis index - positions in Consumer Goods (19.8% of the total), Consumer Services (18.6%) and Technology (12.8%), while being underweight in Financials (19%) and Industrials (18%), with an estimated income yield of 2.4%.
By company size, the portfolio – which usually features between 60-120 constituents - is split almost exactly equally between companies with a market worth of more than £1bn (50.7%) and those valued at less (49.3%). Drilling down to individual names, the manager’s focus on quality and growth is evident from the largest positions; as at 31 May: Games Workshop (4.7% of portfolio), Future (4.4%), Dunelm Group (3.6%), Team17 (3.3%) and Judges (3.2%). Currently priced at a 12% discount to its net asset value (NAV), the shares appear capable of closing that gap to just 1 or 2% - as was the case before the Covid-19 induced crisis – on any improvement in sentiment towards the domestic economy.
Schroder UK Mid Cap investment trust also possesses a diversified portfolio of circa 60 UK company shares, but typically its average constituent has a higher market capitalisation than Georgina Brittain’s fund, as its objective is to provide a total return in excess of the FTSE250 (ex-investment companies) index. After the FTSE100, the next 250 largest UK quoted companies form the FTSE250 index; the average size of its constituents is just north of £1bn and includes famous international businesses like Carnival as well as well-known domestic concerns like Marks & Spencer or Greggs. Another longstanding fund manager Andy Brough, assisted more recently by Jean Roche, has outperformed his benchmark. Over the past 1, 3, 5 and 10 years to 31 May 2020 the shares have produced a total (income, plus capital appreciation) annualised return of -9.0%, -1.7%, +1.0% and +12.1%, (as compared to the benchmark’s -10.5%, -4.1%, +0.2% and +8.5%) respectively.
Both the JP Morgan and the Schroder portfolios are based on a ‘bottom-up’ approach of selecting individual companies, rather than being driven by a ‘top down’ assessment of macro-economic factors. This can perhaps be seen via an element of ‘overlap’ in stock choice: as at the end of May, Schroder UK Mid Cap investment trust’s largest individual exposures were Dunelm Group (4.8%) and Games Workshop (3.4%), with Spectris (3.3%), Telecom Plus (3.3%) and Diploma (3.2%) making up the top five.
Nevertheless, an analysis of broader business sectors shows greater divergence – in part reflecting the different benchmarks – with the Schroder portfolio featuring an overweight position in Industrials (29.1% of the total), Consumer Services (22%) and Consumer Goods (12.4%). By contrast, Andy Brough was underweight in Financials (21.8%). A 12% discount to NAV also appears to undervalue the potential for the UK to successfully embrace Brexit, to survive Covid-19 and for a portfolio of medium or smaller sized businesses to outperform larger ones.
Looking beyond those two well-diversified investment trusts, the reader might be interested in a higher risk-reward investment in UK smaller companies: Strategic Equity investment trust which endeavours to combine the best elements of public equity investors (who typically seek growth in attractively valued businesses) with the main focus of private equity investors (corporate activity and financial engineering). Managed by Jeff Harris and Adam Khanbhai since February 2017, they seek to work with the management of their limited list of investee companies with the objective of enhancing shareholder value. Although not constrained by size, the normal maximum number of portfolio constituents would be 25 - selected from the FTSE Small Cap and AIM segments of the London stock exchange, but also potentially including unquoted investments.
Currently the portfolio has 21 constituents, and the concentrated persona is evidenced by the top ten holdings accounting for almost 70% of total worth. As at 31 March 2020, the largest sectors by business activities were: Healthcare (27.8%of the portfolio), Support Services (16.5%), Technology (15%) and Financials (12.4%). But, more significant are the size of the ten largest individual holdings: Equiniti (11.9% of NAV), Clinigen (10.4%), Tribal (7.4%), Ergomed (6.8%), XPS Pensions (6.1%), Tyman (6%), Alliance Pharma and Medica (5.3% each), Wilmington (4.9%) and Brooks MacDonald (4.7%). In looking at these ten stocks, there is a distinct flavour of growth at reasonable value in prospect – with forward-looking (albeit difficult to quantify post-Covid 19) earnings multiples between 8 and 18. Strategic Equity’s prime attraction is that its share price of just under £2 seems to significantly undervalue (current discount 19%) the net asset worth of the trust’s portfolio.
Finally, it should be reiterated that the author is not making specific investment recommendations – but would rather encourage the reader to carry out their own investigation into prospective stock exchange investments, and consider the above mentioned trusts by reference to their own personal circumstances, individual objectives and appetite for risk-reward.
The Writer's views are their own, not a representation of London South East's. No advice is inferred or given. If you require financial advice, please seek an Independent Financial Adviser.