The trust has made average annualised returns of more than 25 per cent over the past five years, a period where the bottoming out of markets in the wake of the financial crisis brought about a bull-run in small cap stocks.
According to FE Analytics, the Numis Smaller Companies ex Investment Trusts index has nearly doubled the returns of the FTSE 100 over the past five years.
In 2014 this trend has shown signs of faltering with the small-cap index slightly down while the FTSE 100 has gained 3.55 per cent.
Performance of indices over 5yrs
Source: FE Analytics
Hermon says smaller companies can continue to grow although he says macroeconomic headwinds, largely due to rising interest rates, will slow the past five years’ boom.
“I don't think returns of the last five years are achievable in the next five years but I feel cautiously optimistic. As long as the macro doesn't deteriorate materially I think the market could make more progress from current levels,” Hermon (pictured) said.
“It was a phenomenal time to buy equities in 2009 as they were on 8 times P/E. There was some dislocation in the market with the financial crisis in full swing. It can stay consistently at double digit returns in this portfolio over the next five years.”
“I think 25 per cent is challenging and I would be fool hardy to expect that but there is still decent returns to be made form a portfolio of mid and small cap companies.”
Despite expecting a slower market, Hermon says he is optimistic for the stocks he is currently holding in the fund, which he says will stand up in a slower market better than most.
“Some of the returns have been driven by that re-rating in the market but I would counter that the growth in my portfolio’s earning has been strong over that period so I don't see why my portfolio can materially re-rate.”
Hermon has been the trust’s manager since 2002, during which he has beaten the average return in the IT UK Smaller Companies sector in every discrete calendar year over the past 10 years apart from 2007 in which a loss of 18.26 per cent was significantly more than an average loss of 4.17 per cent.
It is also behind the sector and index in 2014 suggesting the trust performs relatively better than its peers when markets are rapidly rising.
It is still ahead of both sector and benchmark over one, three, five and ten years, however.
According to FE Analytics, since Hermon has been running the trust it has returned 587.39 per cent compared to a sector average of 383.2 per cent.
The trust’s benchmark – the NUMIS Smaller Companies index ex ITs – gained 385.42 per cent over the same period.
Performance of trust, sector and index since Dec 2002
Source: FE Analytics
The trust’s discount has widened considerably over the course of 2014 and is currently at 15.5 per cent according to data from the AIC.
Although, our data shows it had traded on a wider discount than that at times over the past five years and until the beginning of year was on a clear trend of narrowing.
Discount/premium of trust over 5yrs
Source: FE Analytics
The prospect of rising interest rates over the course of the next five years is the primary reason he expects markets to slow.
“I think valuations are reasonable and growth will accelerate from the current level with a pick-up in M&A helped by strengthening balance sheets and improving corporate confidence. However, there are lots of headwinds.”
“There is no reason the market cannot re-rate further. It could happen but it is dangerous to expect that.”
“We have gone through a period of very low interest rates and that will start to change. Although it will be well-flagged by central banks in advance, we do think rates are going to go up next year in the UK and the US.”
He also says geopolitical risk and domestic political risk are also a potential catalyst for further market weakness.
“In the short term Scottish Independence would have a negative impact. Six months later we have a general election and it is very unclear as to what government we are going to get. Is it going to be a hung parliament or it is going to be a clear win for Labour or the Conservatives?”
“Geopolitical concerns abound as the world is currently a fairly uncertain place and that raises investors’ concerns.”
Henderson UK Smaller Companies has ongoing charges of 0.46 per cent, but has a 15 per ecnt performance fee on top of that. It is 9 per cent geared.
