Standard Life UK Smaller Companies, BlackRock Throgmorton and Invesco Perpetual UK Smaller Companies are among some of the best UK small-cap trusts at offering strong returns and income generation over the long term, according to Kepler Partner’s Alex Paget (pictured). 
This comes following an article published last week, in which the research analyst explained the benefits of remaining patient and holding onto UK companies further down the cap spectrum.
While he pointed out that they can suffer short term volatility, Paget’s research found that – had investors bought into the Numis Smaller Companies ex IT index at the worst possible time within the last 25 years (18 May 2007) – they would have had to wait 43 months to regain their losses. If they had held out for 10 years, however, they would have doubled their total return relative to investing in the FTSE 100 index over the same time frame.
“We believe that the most important protection that an investor has is keeping a long-term time frame and sticking with the sector,” he said.
In the below article, the research analyst discusses four discounted investment trusts in the IT UK Smaller Companies sector which he believes will achieve high capital growth and income generation over the long term.
Standard Life UK Smaller Companies
First up is the £373m Standard Life UK Smaller Companies trust, which has four FE Crowns and has been headed up by FE Alpha Manager Harry Nimmo since 2003.
Over this time frame, it has comfortably doubled its average peer and benchmark with a total return of 1,083.03 per cent and has done so with a top-quartile maximum drawdown (which measures the most money lost if bought and sold at the worst possible times), Sharpe ratio (which measures risk-adjusted returns) and annualised volatility.
Performance of trust vs sector and benchmark under Nimmo
Source: FE Analytics
Paget said: “[The trust] has performed strongly this year with NAV total returns of 23.6 per cent since the start of January to the end of September.
“In part, this has been driven by the manager’s decision to reduce exposure to the UK economy and consumer following the EU referendum result, creating a tilt towards stocks that generate a large proportion of their earnings overseas – leading to a portfolio that is less exposed to sterling weakness.
“Recent portfolio changes have meant the board had to use a portion of its revenue reserves to fund its latest dividend, although the manager expects the trust’s earnings per share growth to pick up again over the next 18 months given the outlook for many of these higher growth stocks.
“[This means] the manager is confident he and the board can maintain its strong, long-term rate of dividend growth (its compound annual growth rate of the trust’s dividend has been 23.7 per cent over the past 10 years).”
The trust – which is trading on a 6.8 per cent discount to NAV – has a concentrated portfolio, with its 10 largest holdings accounting for 58.7 per cent of the overall vehicle. Its largest individual holdings include Fever-Tree Drinks, healthcare chain NMC Health and fund administration provider Sanne Group.
Standard Life UK Smaller Companies yields 1.4 per cent and has an ongoing charge of 1.08 per cent.
Invesco Perpetual UK Smaller Companies
Next on Paget’s list is the four crown-rated Invesco Perpetual UK Smaller Companies trust, which has been managed by Jonathan Brown since 2002.
The £174.3m trust aims to provide a strong long-term total return through a portfolio of stocks with strong balance sheets, which are capable of self-help rather than being dependent on the broader economy.
Examples of its largest holding include Dechra Pharmaceuticals, outsourcing business Equinity and textile rental service Johnson Service. However, the portfolio is highly-diversified, with its top 10 holdings accounting for approximately one-quarter of the overall fund.
“With an undersubscribed tender earlier this year, Invesco Perpetual UK Smaller Companies trust now has a rebalanced shareholder base of supportive long-term investors,” Paget explained.
“The proven and consistent investment strategy has delivered strong risk-adjusted returns over many cycles, with below average volatility.”
Over five years, the trust has returned 166.85 per cent compared to its average peer and Numis Smaller Companies ex Investment Companies benchmark’s respective returns of 130.57 and 101.18 per cent.
Performance of trust vs sector and benchmark over 5yrs
Source: FE Analytics
In terms of risk metrics over this time frame, it is in the top quartile for its maximum drawdown, Sharpe ratio and annualised volatility.
“Income earned by the portfolio is boosted by a small contribution from capital profits, and means the shares currently yield 3.5 per cent,” Paget continued. “In this way, the trust offers a significant yield premium relative to peers, achieved without compromising the manager’s long-standing and highly successful investment process.”
Invesco Perpetual UK Smaller Companies is trading on a 7.2 per cent discount and has an ongoing charge including a performance fee of 1.27 per cent.
Paget said Mike Prentis and Dan Whitestone’s BlackRock Throgmorton Trust could also present itself as a good option for investors.
Since Prentis took to the £506m trust’s helm in 2008, it has outperformed its average peer and benchmark by 104.47 and 102.91 percentage points respectively with a total return of 336.65 per cent. It has done so with a top-quartile Sharpe ratio but a third-quartile annualised volatility and maximum drawdown, suggesting it may not be best-suited to the more cautious investor.
Performance of trust vs sector and benchmark under Prentis
Source: FE Analytics
Paget said: “[This is] a growth- orientated trust that has delivered strong outperformance over the course of 2017 due to the managers’ decision to decrease the portfolio’s overall exposure to the UK economy and consumer spending power.
“Furthermore, it has one of the fastest rates of dividend growth in the sector (20 per cent per annum over five years).
“This looks likely to continue, given its revenue return per share was 5.44p for the first six months of the year, representing an increase of 45 per cent compared to the equivalent period last year.”
The research analyst said one of the trust’s distinguishing features is its CFD (contracts for difference) portfolio, which allows Prentis and Whitestone to change their overall exposure to the market and profit from underperforming stocks via their short book.
BlackRock Throgmorton is trading on a 15.4 per cent discount, is 24 per cent geared and yields 1.8 per cent. It has an ongoing charge including a performance fee of 1.34 per cent.
Rights & Issues
The final trust on Paget’s list is the five crown-rated Rights & Issues investment trust, which is £202m in size and is headed up by Simon Knott.
Paget said Knott is a highly-experienced bottom-up stock-picker. Over the last five years, for instance, the trust has returned 233.07 per cent compared to its average peer and benchmark’s respective returns of 130.57 and 60.81 per cent. It has done so with a top-quartile Sharpe ratio, a second-quartile maximum drawdown and a third-quartile annualised volatility.
Performance of trust vs sector and benchmark over 5yrs
Source: FE Analytics
“These returns have been lowly correlated to the index,” Paget explained. “The trust has a very strong track record of NAV outperformance, though hadn’t necessarily been the most attractive offering for wealth managers and professional investors due to a persistently wide discount, low liquidity, lack of marketing and complicated structure – and therefore wasn’t one we would usually cover.
“However, as we illustrate in our note on the trust, the board has taken many positive steps in making the trust more appealing to a wider audience of investors – and these have already benefited shareholders.”
Rights & Issues is trading on a 10.7 per cent discount, yields 1.4 per cent and has an ongoing charge of 0.59 per cent.