Acorn Income, which has a clear small-cap bias and been the best performing portfolio in the IT UK Equity & Bond Income sector since its launch in February 1999, saw its discount widen significantly following the news of FE Alpha Manager John McClure’s death in June this year.
This caused the closed-ended fund to underperform over recent months.
It had been a very popular trust among retail investors due to McClure’s disciplined approach to small and mid-cap dividend paying companies and, according to the AIC, had traded on a 4.6 per cent premium at points over the last 12 months.
Having recently met with Simon Moon and Fraser Mackersie, the new managers who worked closely with McClure over the past sixed years, Elliott says they are well-placed to replicate McClure’s strong track record.
“Acorn Income has seen its discount widen following the announcement of John McClure’s death,” Elliott (pictured) said.
“He was a well-respected fund manager and is a sad loss to Unicorn. However, Simon Moon and Fraser Mackersie worked with John for a number of years and clearly share his approach to investing. As a result we would not expect any significant changes in the short term.”He added: “With a yield of 3.7 per cent, we believe that the current discount presents an attractive entry point into Acorn Income. In our view the new management team will be highly incentivised to maintain the fund’s strong long-term track record.”
According to FE Analytics, Acorn Income trust has returned a hefty 681.74 per cent since its launch in February 1999, more than doubling the returns of its benchmark – the Numis Smaller Companies ex IT index – which has gained 316.47 per cent over the period.
Performance of trust vs sector and index since Feb 1999
Source: FE Analytics
The closed-ended fund has also beaten its benchmark, and been the best performing portfolio in the sector, over three, five, seven and 10-year periods.
Source: FE Analytics
Acorn Income is now managed by Simon Moon and Fraser Mackersie.
Both managers have assumed full responsibility of the five-crown rated Unicorn UK Income fund, after becoming co-managers with McClure last year. They also run their own individual open-ended funds, with Moon in charge of Unicorn UK Smaller Companies and Mackersie heading up Unicorn UK Growth.
Both the Unicorn UK Smaller Companies and UK Growth funds have beaten their respective benchmarks and IMA sectors since the two managers have been at the helm.
There is no denying it has been a tough few months for Moon and Mackersie. Not only have they lost their colleague, but McClure’s death coincided with a poor period for mid and small-caps as investors have been taking profits and moving into larger companies in the face of growing market risks.
The trust’s NAV is down 9 per cent since McClure’s death and, due to its widening discount, it has lost more than 13 per cent in terms of its total return.
Both the sector and index have lost money over that time, but they are down around 4 per cent.
Performance of trust vs sector and index since June 2014
Source: FE Analytics
Despite its tough run, Ewan-Lovett Turner – associate director of investment companies research at Numis – agrees that now is a good time to buy.
“I think at its current 13.5 per cent discount, it could well be [a good buying opportunity] compared to where it has been,” Lovett-Turner said.
“There was some uncertainty after McClure’s death however, Simon and Fraser had been working with John since 2008 and are very much indoctrinated into the process. They are sticking to the well-defined bottom-up approach and I would expect them to deliver similar sort of return profile.”
While most agree that Acorn Income looks attractive on its current discount, the major question is whether investors want to be buying a small and mid-cap trust at this stage in the cycle.
Smaller companies had been some of the major beneficiaries of the recent bull market, with the Numis Smaller Companies index returning 25.71 per cent in 2012 and a further 31.73 per cent in 2013.
Though the index has fallen more than 6 per cent since the initial sell-off in March, a number of experts have warned that small and mid-caps could continue to underperform against the FTSE 100 in the face of geo-political risk between Russia and the West, the end of QE in the US and the talk of higher interest rates in the UK.
Nevertheless, Lovett-Turner says now is as good an entry point into small and mid-caps as any for a long-term investor.
“Certainly, valuations look at lot more attractive than they have been. They have had a tremendous run over recent years so it is hardly surprising that we have seen a bit of a pull-back from those levels.”
He added: “However, I think people could be able to capitalise from these levels.”
Moon and Mackersie hold 33 per cent of the trust’s NAV in the FTSE 250, 34 per cent in the FTSE Small Cap index, 20 per cent in the FTSE AIM and 8 per cent in the FTSE Fledgling index.
Unlike Unicorn UK Income, Acorn Income has no exposure to the FTSE 100.
Elliott likes the strategy used on the trust, which is based around fundamental stock selection. The companies they look for have to be profitable at the time of investment, have strong balance sheets, have significant market share – preferably in a niche industry – and have the ability to pay a dividend.
The smaller companies portion of the portfolio accounts for 70-80 per cent of NAV, while the rest is split across fixed interest assets which are there to generate extra income. They also use shorts in the fixed income section to hedge against rising interest rates.
The analyst says Moon and Mackersie have been rotating the portfolio recently.
“The portfolio’s focus has changed from a year ago, when the emphasis was on companies with overseas' earnings, to those with exposure to domestic recovery. This is reflected in the higher exposure to financials, logistics and specialist retailers, such as Conviviality Retail,” Elliott said.
“A couple of the lower conviction holdings have been sold in the last month.”
“The managers believe that after the recent sell-off the valuations of UK mid and small cap companies look attractive. They have also backed a number of IPOs in the last year, including; River & Mercantile, Clipper Logistics, Flowtech Fluidpower, Safestyle UK and DX.”
Acorn Income has ongoing charges of 0.7 per cent, but it also has a performance fee of 15 per cent.
The trust is geared at 44 per cent; however that figure looks very high because it incorporates its zero dividend preference shares, which are set to be redeemed in January 2017 at 130p.
