Managers of open-ended funds must carefully consider the liquidity of their holdings, because they may need to sell assets to meet redemptions. Since small and mid-sized companies are less liquid than larger companies, this means that most open-ended funds will often be quite restricted in how much they can invest in smaller-cap stocks. Some of the best companies are out of reach of most open-ended funds.
This is a key advantage of investment trusts when investing in sectors such as this. Investment trusts don’t run the same risk of having to sell assets in a hurry because investors are suddenly pulling their money out. That enables them to take a longer-term and more value-oriented view.
Core choices in the investment trusts sector
So what are some of the core options in the sector? The largest small- and mid-cap trust, with £2.2 billion in assets under management (including gearing of 14% at present), is Mercantile Investment Trust (LSE: MRC), managed by JPMorgan. The trust has a five-year total return in net asset value (NAV) terms of 10.6% per year – 0.9 percentage points ahead of the FTSE All-Share, excluding FTSE 100 stocks and investment companies. It has also beaten its benchmark over three years and 10 years. The discount to NAV is 10%.
Sign up to Money Morning
Don’t miss the latest investment and personal finances news, market analysis, plus money-saving tips with our free twice-daily newsletter
Don’t miss the latest investment and personal finances news, market analysis, plus money-saving tips with our free twice-daily newsletter
The largest trust focused on small caps is Aberforth Smaller Companies (LSE: ASL), with £1.4 billion in assets, and gearing of just under 3%. It also trades on a discount to NAV of 10% and portfolio valuations offer a further discount – its holdings trade on a price/earnings ratio of seven times forecast earnings, 22% below the average for its investment universe. The NAV return over five years is 14.7% per year.
Henderson Smaller Companies (LSE: HSL) employs a growth at a reasonable price (Garp) strategy, focusing on high-quality companies with strong balance sheets and competitive market positions. The long-term return has been strong, with NAV total returns of almost 12% since November 2002, when joint manager Neil Hermon – who retires this month – was appointed. However, performance has deteriorated in the past five years, with a return of 5% per year. Gearing is 13% at present, and the discount to NAV is slightly under 9%.
Income investors could look to JPMorgan UK Small Cap Growth & Income (LSE: JUGI), which adopted a new dividend policy following the merger of JPMorgan’s mid-cap and small-cap trusts last year. The trust now pays quarterly dividends totalling 4% of end-July NAV each year. This requires a quality focus: the portfolio has a free cash-flow yield of 8.5% (compared with the index’s 5.5%) and a return on invested capital (ROIC) of 15% (against 9% for the index). The five-year NAV return is 9.5% per year. Gearing is around 8% and the discount to NAV is 7.5%.
Investment trusts for focused portfolios
Odyssean Investment Trust (LSE: OIT) and Rockwood Strategic (LSE: RKW) are worth considering for focused portfolios. Both are run by managers at Harwood Capital, but with different approaches: Rockwood is keener on smaller stocks and recovery plays.
Odyssean’s top four holdings make up more than half its portfolio. More than 10 of its holdings have been taken over since it launched, often at a significant premium. The five-year NAV return is 8.5% per year and the discount to NAV is 6.5%. Rockwood’s top 10 holdings make up 60% of the fund, which has returned roughly 21% per year over five years. The shares often trade at a premium (currently 1%).
Rupert will be hosting an evening event on UK investing in association with Law Debenture on Wednesday, 17 September in London and online. Go to lawdebenture. com/events/winstar-wideninginvestor-networks for details.
This article was first published in MoneyWeek’s magazine. Enjoy exclusive early access to news, opinion and analysis from our team of financial experts with a MoneyWeek subscription.
