Following a phenomenal run in 2013, UK smaller companies had a very difficult time of it last year as investors looked to lock in gains when growing macroeconomic headwinds prompted them to take less risk within their portfolios.
While there are clearly still concerns about UK equities given it is an election year and as most of the issues which plagued the market last year have not yet been resolved, the analysts at the broker think that now is a good opportunity for investors to gain exposure to the high growth asset class.
As a result, they have moved the large and liquid Aberforth Smaller Companies trust, which is co-managed by Alistair Whyte, Richard Newbery, Andrew Bamford, Euan Macdonald and Keith Muir, onto their recommendation list as they rate the management team highly and think there is little downside risk given that it now trades on a double-digit discount.
“Aberforth Smaller Companies has an impressive long-term record and we believe that it looks well placed to deliver attractive returns, supported by rising M&A activity,” Numis said.
“Valuations of UK smaller companies are now at a discount to large caps, with a historic P/E multiple of 13.2 times, and we believe Aberforth, itself, offers value [on its current discount]. The fund pays a yield of 2.4 per cent, with a progressive dividend policy, and is the largest investment trust in the peer group with a market cap of £997m.”
They added: “As a result, we regard it as a core holding for investors in UK smaller company funds.”
Aberforth Smaller Companies was launched by Whyte and Newbery way back in December 1990 and while the fund’s very long-term numbers have been strong, over other time frames the returns have been less appealing.
Our data on the trust goes back to January 1995 and over that time it has returned 854.16 per cent, beating its benchmark – the Numis Smaller Companies ex IT index – by more than 200 percentage points in the process.
Performance of trust versus index since 1995
Source: FE Analytics
However, while the closed-ended fund is up 154.80 per cent over 10 years, it has lagged behind both its benchmark and the wider IT UK Smaller Companies sector over that time.
Numis says the reason why it has struggled relative to the wider marker over that time is because of the managers’ value-orientated approach to small-caps. During most of the last decade, growth has been the most rewarding strategy.
However, that has started to change over recent years and the team’s focus on value, along with a tightening discount, means the trust has performed strongly over nearer time frames.
Aberforth Smaller Companies returned 43.87 per cent in 2012 when the index was up 29.94 per cent, 61.98 per cent in 2013 when the index returned 36.93 per cent and in last year’s turbulent market the trust made a slight positive return while its benchmark lost money.
Our data shows it has returned 125 per cent since January 2012, making it the sector’s fourth best performer over that time and meaning it has beaten the index by 50 percentage points.
Performance of trust versus sector and index since Jan 2012
Source: FE Analytics
While the trust’s NAV has held up well so far this year, its discount has widened significantly in 2015 from 7 per cent at the start of the year to its current figure of 11.75 per cent.
It is now trading on a wider discount to NAV than its one and three-year averages, according to the AIC, as Aberforth Smaller Companies had been on a 1 per cent discount at points over the past 12 months.
Numis therefore says it looks attractive for long-term investors looking for core exposure to the UK small cap market, especially as they would be gaining access to a very high quality management team.
“The portfolio is well diversified, with 88 holdings, and the top 10 investments representing 27 per cent of net assets,” Numis said.
“As an active manager, however, Aberforth seeks to add value through the construction of a portfolio that differs from the benchmark, and has a target to maintain its active share over 70 per cent. It was 77 per cent at 1 January 2015.”
The managers are currently overweight industrials, consumer services and technology and they are looking to take advantage of a further indiscriminate sell-off in share prices of smaller oil companies, according to the team at Numis.
On the other hand, Aberforth Smaller Companies is underweight consumer goods, financials and basic materials and it must be pointed out that, unlike many of their peers, the managers won’t invest in FTSE AIM-listed stocks.
The other major reason why Numis have moved the trust onto their recommendation list is due to its dividend characteristics; the team suggests it is a decent offering for investors looking for a growing source of income.
Trust’s historic yield and dividend growth
Source: Aberforth/Numis
As the graph above shows, Aberforth Smaller Companies, which currently yields 2.4 per cent, has a good history of growing its dividend and the analysts don’t expect that to stop given that its average holding’s dividend cover is three times.
“The annual dividend rose 5.3 per cent, reflecting the board’s commitment to a progressive dividend policy, and was fully covered by earnings of 27.24p. Half of Aberforth’s 88 portfolio holdings increased dividends during in 2014, with just seven cutting dividends.”
“However, the company currently holds 20 non-dividend payers representing 17 per cent of the portfolio by value. This is because the managers found attractive valuation opportunities among non-dividend payers in 2014, and many of these are expected to recommence dividend payments over the next few years.”
“Furthermore, Aberforth has revenue reserves of 38.6p per share, after adjusting for the final dividend, suggesting that it should be able to maintain the growth in its annual dividend.”
Aberforth Smaller Companies has gearing of 3 per cent and ongoing charges of 0.79 per cent.
