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Buying opportunity in small cap trusts, says Troue

09 June 2014

Sliding prices in UK smaller companies have opened up a buying opportunity in investment trusts, says Hargreaves Lansdown’s Richard Troue.

By Jenna Voigt,

Editor, Investazine

Investors should be looking to buy in to UK small caps after their sell-off of the past few months, according to Richard Troue, analyst at Hargreaves Lansdown.

After a period of stellar performance, smaller companies have suffered in recent months, falling behind their large cap counterparts.

Troue (pictured) says the turn in sentiment has opened up a buying opportunity, particularly in the investment trusts, where investors can benefit from a narrowing discount as well as capital appreciation in the underlying assets. 

ALT_TAG “Over the long term UK smaller companies are a good place to be,” he said. “I certainly think one of the advantages of the investment trust structure is that when sentiment does turn many opportunities can open up.”

“It can present an interesting opportunity and I would take advantage of it. UK smaller companies are a good place to be and can be an overlooked place to be. I’d take any setback as an opportunity to top up.”

Over the last six months the FTSE Small Cap index is up 4.95 per cent while the blue-chip FTSE 100 index has gained 5.92 per cent, according to FE Analytics. The FTSE All Share is up 5.85 per cent over.

Performance of indices over 6 months

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Source: FE Analytics

Smaller companies have been even harder hit over the last three months and are down 1.7 per cent while large caps are up 1.58 per cent.

Troue says the manager he rates for access to UK smaller companies is FE Alpha Manager Harry Nimmo (pictured), who is best known for his open-ended Standard Life UK Smaller Companies fund. 

ALT_TAG However, the manager also heads up the closed-ended Standard Life UK Smaller Companies trust, which is currently trading on a discount of 4.11 per cent, much wider than its three year average discount of 1.75 per cent. Earlier this year, the trust was trading on a premium of 4.96 per cent.

Troue says the manager has had a tough time recently, as quality companies have been out of favour.

Instead of the market switching from low quality to high quality, it has moved into value, which has left Nimmo’s style behind the market, he explains.

It has also been hit by the collapse in the share price of major holding ASOS as well.

While the trust has trailed its peers in the IT UK Smaller Companies sector and the Numis Smaller companies ex Investment Companies index over the last one and three years, it smashed both measures over the last decade, returning 594.63 per cent. harry

Performance of trust vs sector and index over 10yrs

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Source: FE Analytics

“The trust does tend to trade on a narrower discount than a lot in the sector,” Troue said.

This is why he also likes the four FE Crown rated BlackRock Smaller Companies trust, managed by Mike Prentis, and the BlackRock Throgmorton Trust, which is run by Prentis and FE Alpha Manager Richard Plackett, though Plackett is currently on sabbatical.

The BlackRock Smaller Companies trust is trading on a discount of 10.53 per cent, wider than its one year average of 7.79 per cent. Earlier this year, the trust was trading on a small premium of 0.11 per cent.

The Throgmorton trust is even cheaper, running a discount of 14.11 per cent. Over the last year it has traded on an average discount of 11.17 per cent.

Both trusts have delivered strong outperformance over the medium and long-term relative to the sector and index. Blackrock Smaller Companies IT delivered an impressive 463.32 per cent over the last decade, while Throgmorton returned 307.82 per cent.

Performance of trusts vs sector and index over 10yrs

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Source: FE Analytics

Both trusts have had a more difficult time in recent months, with the Smaller Companies trust losing 5.03 per cent in the last month. Throgmorton is down 4.76 per cent in that period.

In Troue’s eyes, the short term performance dip is a good chance to buy in this long-term sector.

These three trusts aren’t the only ones that have seen their discounts widen in the recent sell-off in small caps.

Phil Webster, manager of the multi-asset Aberdeen Smaller Companies High Income trust, says the correction in smaller companies has driven his trust down to a wide discount of 11.6 per cent.

“The discount has blown out on the trust,” he said. “It has been on a premium six months ago.”

The manager admits; however, that it’s unusual for the trust to trade on a wide premium, as was instead a sign the market was getting toppy.

“A moderate discount seems about fair [for the trust],” he said.

Over the last year, Aberdeen Smaller Companies High Income has been trading on an average discount of 5.32 per cent. It is currently on par with its average discount over the last three years of 11.5 per cent.

“We’ve seen a little bit more volatility in the last two or three months. Some has been stock specific and some has been headwinds from companies. [Much of it] is valuation related. Small companies got ahead of themselves as did most things,” he said.

“Sometimes I like a bit of volatility because as people are running for the door, it gives us an opportunity to put some bets on the table.”

However, the manager says there are plenty of opportunities to pick up cheap stocks at the moment, particularly as corporate earnings are starting to seep through.

Webster, who is also able to hold a small allocation to bonds in his trust, says he doesn’t see much value in the asset class, instead preferring to allocate to equities.

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