History has shown that over most long-term time frames smaller companies have delivered higher returns to their investors than large-caps.
That has certainly been the case in the global equity sectors – which are the usual hunting ground for UK investors looking to diversify their portfolios away from their more domestic-orientated funds.
According to FE Analytics, the MSCI World Small Cap index has doubled the MSCI AC World index’s gains over the past 10 years with returns of more than 140 per cent.
Performance of indices over 10yrs
Source: FE Analytics
Unfortunately, there aren’t a huge amount of open-ended funds which focus on global small-caps and one of the constant worries about OEICs and unit trusts which own smaller companies is their size – as a growing AUM leads to liquidity constraints which, in turn, can dilute returns or bring about a change in approach.
However, investment trusts have several clear advantages for small cap investing. Due to their share structure they don’t have to worry about inflows and outflows and therefore size to the same extent as open-ended funds and investors are incentivised to hold for the longer term.
With this in mind, in this article we take a look at two small cap focused investment trusts with a track record of beating their peers: F&C Global Smaller Companies and Edinburgh Worldwide.
Both trusts have been around for more than 15 years but the first clear difference is the management team of Douglas Brodie [lead manager] and John MacDougall [co-manager] have a relatively short tenure of just 18 months on Edinburgh Worldwide compared with Peter Ewins at F&C Global Smaller Companies who has headed the trust for a decade.
The two FE Alpha Managers had a torrid 2014 after taking over Edinburgh Worldwide with the trust in negative territory until February of this year.
However, the trust has rallied in recent months and it has up 17.79 per cent since the pair took over – almost all of this is due to the movement of the underlying shares and not to a change in its discount. It is currently on a 4.3 per cent discount.
However, while this is ahead of the IT Global sector average, it is a touch behind the gain in the MSCI World Small Cap index.
Performance of trust, sector and index since 27 January 2014
Source: FE Analytics
Kieran Drake, analyst at Winterflood Securities says Edinburgh Worldwide new management team and greater focus on smaller companies – firms with a market cap of less than $5bn - should make an interesting investment over the longer term.
He says it is looking to identify “the large-cap companies of tomorrow” especially for firms with a high growth and disruptive agenda. However, Drakes adds it is a high risk trust.
“Douglas Brodie has generated a strong performance record with this strategy through his equivalent open‐ended fund [the Baillie Gifford Global Discovery fund],” Drake said.
Overall the biggest tilt is to the US, with 40 per cent of the portfolio in that country and a further 30 per cent in the UK, 12 per cent in Europe and 7.5 per cent in Japan. Current top 10 holdings include the likes of Tesla, TripAdvisor and IP Group.
F&C Global Smaller Companies has no stocks in common with Edinburgh Worldwide in its top 10 but is has an almost entirely identical regional allocation. That is where the similarities end though, according to Charles Cade at Numis Securities.
“The investment approaches [of the two trusts] are very different,” he said.
“Edinburgh Worldwide, having adopted a mandate to focus on smaller global growth companies, is now earlier stage than the £3bn Scottish Mortgage Trust [which is also run by Baillie Gifford]. It is more diversified with 90 holdings and, although the aim is to ‘run the winners’, the emphasis is on long-term growth prospects and 25-30 per cent of the portfolio is loss-making/break even.”
“At F&C Global Smaller Companies Ewins employs a 'growth at the right price' investment approach, with a focus on the quality of management, its market positioning/strategy and financial strength.”
Apart from the F&C Global Smaller Companies’ direct equity exposure, it is invested to about 15-20 per cent in other investment trusts and funds.
Its largest holdings are M&G Japan Smaller Companies, Aberdeen Global Japanese Smaller Companies, Scottish Oriental Smaller Companies, Manulife Global Asian Smaller Companies and Aberdeen Global Asian Smaller Companies.
This reflects Ewins recent bullishness on Japan, which has been the biggest driver of returns for the trust over the past year however this is now a neutral position relative to the benchmark.
Ewins has managed this trust for just over decade since which it has returned 245.54 per cent versus an IT Global sector average of 115.68 per cent. This makes it a top decile performer over five and 10 year periods.
Performance of trust versus sector since 2005
Source: FE Analytics
More recently, Ewins has said, the portfolio has reflected a weaker oil price the team reviewing the balance sheet risk of oil related investments, and subsequently focusing on those with relatively strong balance sheets. They have also been looking for firms they perceive to be beneficiaries of lower oil prices particularly in relation to consumer spending.
Europe is now the fund’s biggest overweight although it’s largest weighting is to the US with around 40 per cent of the portfolio in these stocks, with the index about 50 per cent US.
Its discount has remained unchanged at close to neutral for most of the past two years and currently is 0.8 per cent.
Cade says he backs both trusts but says they play different roles in a portfolio and may have differing levels of volatility depending on market conditions.
“We believe that both funds are attractive ways to get global exposure to smaller companies, albeit with very different risk profiles. We believe that Edinburgh Worldwide has the potential to deliver higher growth, although its returns are likely to be more volatile,” he said.
In terms of charges Edinburgh Worldwide has ongoing charges of 0.92 per cent but F&C Global Smaller Companies is cheaper at 0.53 per cent. It also has lower gearing at 6 per cent compared to 10 per cent for Edinburgh Worldwide.
