UK shares – smaller companies in particular – are the cheapest developed equity market in the world.
“The UK market is trading at a 10% discount to its 20-year average, but… the UK is not just cheap compared to itself; it is the value market at the moment,” Indriatti van Hien, deputy manager of the Henderson Smaller Companies Investment Trust, told delegates at Sub35’s Pewterers’ Hall event.
“It is trading at a 30% discount to other developed markets – those are lows not seen in the last 30 years. That’s important because there’s a lot of money on the sidelines ready to come back into the UK as soon as we get any clarity on Brexit or politics.”
It is not just international investors who have shunned the “pariah” UK equity market. The UK All Companies sector has suffered the worst net retail sales in each of the past five years, Investment Association data shows.
Hien started working with Neil Hermon, who has run Henderson Smaller Companies since 2002, in January 2013 and was appointed his deputy in May 2016. “It feels like a very long time ago,” she said. “’I do promise I am one of you – I am 32. I might not look it because it was very exciting for me to be made a fund manager just days before the EU referendum.”
Though half of the revenues of Henderson Smaller Companies’ portfolio come from outside the UK, smaller companies tend to be more domestically focused and are trading at a discount to large ones, so have an even greater potential to re-rate when investor confidence returns.
“Small cap funds show… faster organic growth, often have higher operating leverage, more entrepreneurial management teams and are more agile in the face of change,” said Hien. “They’re smaller, often younger and are therefore a good source of new technologies and services, which means they are often disruptors.
“They are also key beneficiaries of M&A [mergers and acquisitions]; that’s because large, sleepy FTSE 100 companies buy them to invigorate their own growth.”
Structural benefits
She alluded to the investment trust structure being ideally placed for investing in smaller companies (the bottom 10% of stocks by market capitalisation in the UK, currently valued at £1.5 billion or less), which can be less liquid than larger ones.
She stressed, however, that the trust is the third largest in its sector and not a microcap fund, generally investing in companies worth more than £100 million.
Other key features of the trust, and of the investment trust universe in general, are the ability to:
Buy at a discount to underlying net asset value (Henderson Smaller Companies has net assets of £736 million and a market capitalisation of £669 million);
smooth dividend payments (the trust yields 2.6%, having grown its dividend by a compound 28% since 2003, and has revenue reserves amounting to 1.5 years’ dividends “for a rainy day”);
gear to enhance shareholder returns in a rising market (it is currently 8.5% geared through a 20-year private placement, upon which it pays a “cheap” 3.3%).
Five selling points
Henderson Smaller Companies Investment Trust:
- Stock picks among bottom 10% of UK stocks, typically £100 million+
- Large and liquid trust – third largest in the sector
- Looks for undervalued growth stocks with four Ms – attractive model, generating money, strong management team with vested interests, earnings momentum
- Charges low base fee of 0.35% of net asset value plus 15% of outperformance with total fee capped at 0.9%
- Has grown dividend for 15 consecutive years and outperformed benchmark in 14 of last 15 financial years