These are difficult times for investors in funds with exposure to smaller companies. The shake-out in markets has hit the shares of many smaller companies hard, resulting in sharp price falls.
Nowhere has the pain been more excruciating than at Invesco Perpetual UK Smaller Companies Investment Trust.
Over the past month, its shares have fallen in value by nearly 12 per cent and manager Jonathan Brown – quite candidly – does not believe things will improve until a Brexit deal has been struck.
Even then, a combination of higher interest rates and a raging trade war between the United States and China will threaten to continue to destabilise stock markets worldwide, causing further torment for investors in UK smaller companies funds.
Together with deputy manager Robin West, Brown has been busy trying to protect shareholders from the worst of the market falls, but it has been a struggle Defensive measures include a five per cent cash holding and no expensive borrowings to denude shareholders’ investments.
The managers have also tried to construct a resilient portfolio. But as Brown says: ‘As an investment manager, you do not beat the Federal Reserve. When interest rates rise, equities fall.’
The trust’s portfolio currently comprises 78 holdings, drawn from the bottom ten per cent of the UK stock market by market capitalisation. It includes a number of FTSE 250 listed companies, including thread-maker Coats, pharmaceuticals firm Clinigen, IT consultancy firm FDM and Hilton Foods.
Apart from the ‘smaller company’ label, the common theme across the trust is a focus on businesses that have the ability to grow irrespective of what is happening in the wider economy.
This ‘independence’ may be a result of product innovation, an ability to swallow up rivals and derive economies of scale, or beneficial ‘structural’ change in the industry that a company is operating.
An excellent example of ‘innovation’ is Coats Group, the trust’s second biggest company position.
Brown says: ‘A third of shirts manufactured in the world are held together by thread made by Coats. But what I like is the fact that it has built an internet presence that allows manufacturers to order thread quickly in response to the march of fast fashion.’
In terms of consolidators, Brown says Johnson Service Group is a perfect example.
The company supplies linen and tableware for hire to hotels and restaurants. ‘Johnson has been steadily buying up competitors,’ says Brown. ‘The result is that as it increases customer numbers, it is able to drive down unit costs, resulting in an increase in profits.’
The trust has two features that stand it apart from rivals. First, it is keen to maintain an attractive annual dividend of around four per cent. Second, the managers have the right to charge a performance fee if the trust outperforms its benchmark – the Numis Smaller Companies Index.
This can add an additional one per cent to the annual management fee of 0.65 per cent. In the year to the end of January 2018, a £2.6 million performance fee was taken from the trust’s profits, compared to £1.2 million of annual management fees.
To put this into context, the trust’s assets are valued at just over £150 million.
Despite the fees – or maybe because of them – the trust’s share price has increased by 85 per cent over the past five years. Only two out of 13 other UK smaller companies’ trusts have delivered better returns.