The Standard Life UK Smaller Companies Trust is one of those high performing investment products that, for one reason or another, appears to have fallen out favour.
The trust recently ranked 13th on the 20 most consistent top performing trusts compiled by the Association of Investment Companies – having beat the average in eight years out of ten years.
In numerical terms, the trust, which combs the UK stock market for the best quality small caps, has turned a £1,000 investment into £2,025 over a five year investment horizon (to 15 June 2018).
Uncertainty over the Brexit negotiations has reflected badly on investment products that invest in small UK listed companies including the Standard Life UK Smaller Companies Trust
It was also inaugurated into the trade body’s exclusive ‘dividend heroes’ club for trusts that have consecutively increased their dividend for the past 10 years.
Yet the trust trades at 9.26 per cent less than the sum of its underlying holdings.
This could be because investors are scared of a bout of underperformance, believe the trust’s net asset value is not as much as claimed and/or have lost faith in the manager.
However, a better guess is the trust has been buffeted by a wider apathy to the UK smaller companies sector amid the ongoing uncertainty surrounding the Brexit negotiations.
So should you invest? We take a look.
What is an investment trust?
Investment trusts differ from open-ended funds in a few ways. They are structured like a company, with shares that trade on the stock market and invest in a basket of shares, bonds or property.
They are known as closed-ended as the number of shares or units trading in the trust is limited and finite.
Investment trusts can be riskier than unit trusts because their shares can trade at a premium or discount to the value of the assets they hold, known as the net asset value.
Unlike closed-ended funds – also sometimes called unit trusts – investment trusts are also allowed to raise debt in order to fund investment. This means when markets perform well their investment returns are geared and can outperform the market.
It also exposes investors to risk however, as debt-funded investment can result in bigger losses if markets fall.
How the trust invests
The trust aims to grow investors’ cash over the long term by investing in listed UK smaller companies. It levies an ongoing charge of 1.08 per cent and currently yields 1.34 per cent.
Harry Nimmo, the manager, and his team of analysts, focus their attention on individual stocks rather than on the industry in which that company operates. This is often referred to as bottom up investing.
The trust uses a stock selection system that Standard Life uses across its fund range dubbed ‘The Matrix’ – and no it has nothing to to with the 1999 hit sci-fi film staring Keanu Reeves.
The pie chart shows the portfolio breakdown of the Standard Life UK Smaller Companies Trust (correct to 30 April 2018)
It screens around 650 companies iwith a market capitalisation – market value of a company’s outstanding shares – of up to £1.5billion.
They are then ranked on consistency of earnings, value, growth of profits and price momentum.
This translates to a portfolio with the greatest weighting in the industrial sector (25 per cent) ahead services in second (18 per cent).
The skew to companies that have performed well, rather than looking for cheaper companies often result in the inclusion of shares that tend to be priced more expensively (relative to earnings) than the wider market.
Top five holdings
When it come to performance, the trust has returned 16.35 per cent, 73.44 per cent and 102.46 per cent over one-year, three-year and five-year investment horizons respectively.
To put this into context, the average trust in the Association of Investment Companies’s UK Smaller Companies sector generated less over a one and three year time horizon (14.08 per cent, 50.89 per cent) but more over 5 years 110.41 per cent.
The man behind the trust
The trust is managed by Harry Nimmo who, prior to his career in investments, worked as a geologist in the Middle East.
He joined Standard Life as an investment analyst in 1985, launched the Standard Life’s UK Smaller Companies fund in 1997, and took up management of the UK Smaller Companies Trust six years later – both of which he continues to run.
Nimmo has six principles for successful investing in small-cap equities: look for sustainable growth; go for quality; run your winners; concentrate your efforts; management longevity; and value is not everything.
Sustainable growth and management longevity are among Harry Nimmo’s six principles for successful investing
This philosophy has put him in good stead. A £1,000 investment in funds run by Nimmo over the past 18 years would have have turned into £9,324 – outstripping the £4,815 achieved by the average fund manager who has held a similar brief.
This is according to a tool at website FE Analytics which calculates the average return a fund manager has generated for the funds they’ve run during a given period of time.
Some of Nimmo’s successes include being an early investor in a number of online companies like Asos, Abcam, Rightmove and MoneySupermarket.
In the case of Asos, Nimmo bought a stake in the online fashion and beauty shop at 85p a share, and sold eight years later at an average price of around £47.
Laith Khalaf, senior analyst at DIY platform Hargreaves Lansdown, said: ‘Nimmo’s success has come from a disciplined approach to investing and a preference for companies which have high recurring revenues, and therefore a buffer against things going wrong.
‘He has also shown a willingness to ride his winners, holding onto companies even when they have grown from relative minnows and even entered into the FTSE 100.’
Is the discount a warning sign?
When choosing an investment trust, investors should look at what the premium or discount is compared to the trust’s own history as well as the history of its sector.
At present, the trust trades on a 9.26 per cent discount relative to the sum of its underlying holdings.
The graph shows the divergence between the trust’s share price and NAV
As shown on the graph above, the share price discount to NAV is greater than what it was five years ago. In more recent history, the divergence followed a narrowing trend from June 2017 to December 2017 but has widened ever since.
This is somewhat a reflection of investors’ sentiment on how Brexit will affect small cap listed companies. The ongoing uncertainty over Brexit negotiation makes it difficult to gauge exactly how these stocks will be impacted.
Adrian Lowcock investment director at multi-manager investment firm Architas, said: ‘A poor outcome for Brexit negotiations would impact on UK smaller companies and would impact this trust. However as there is a focus on companies which are not just dependent on the UK economy and on quality I would expect the trust to still outperform its peers.
‘The trust’s focus on quality typically means it should protect capital in a weak market as good quality stock selection helps avoid the worst of any sell off.
‘Nimmo’s investment style means there will be periods the investment style and quality focus will be out of favour. However, this more cautious approach has benefited investors over the longer term.’