What could be the first phase in the bursting of a stock market bubble may have knocked shares of Aberforth Smaller Companies (ASL) as much as many other investment trust in the past fortnight, but it will have also have reassured the value-driven fund managers over prospects for the UK’s largest listed small-cap fund.
In annual results published on 26 January, the £1.2 billion trust reported a 22.1% total portfolio return for the year to last November, ahead of the 19.5% gain in the Numis Smaller Companies (excluding investment companies) index – its benchmark – and the 13.1% from the FTSE All-Share.
With a final dividend of 19.75p lifting ordinary dividends for the year by 5.3% to 28.8p, and accompanied by a special, one-off payment of 6.7p, this was a good result, showing the benefit of a cheap pound on the overseas earnings of its investee companies.
However, Aberforth Partners, the Edinburgh-based fund’s managers, noted that the performance had been weighted to the first half of its financial year.
While the gathering strength of the global economy had initially raised hopes of a ‘reflation trade’ to boost the cheap cyclical stocks it likes, as the year wore on, the slow pace of US tax reform swung the pendulum back to defensive, expensive growth stocks as the yields, or market interest rates, on government bonds subsided and indicated a less positive forecast.
Meanwhile, political and Brexit uncertainties meant small UK quoted companies had by and large missed out on the re-rating of broader financial markets. As a result by December they traded at around a 34% price/earnings discount to larger companies.
‘Since the company’s formation in 1990, only the period during and in the aftermath of the Long Term Credit Management crisis in 1998 has this discount been meaningfully wider,’ said chairman Paul Trickett.
Fortunately, perhaps, the recent spike in yields on 10-year UK government bonds, or gilts, from 1.2% to 1.6% could mean the reflation trade is back on. This could bode well for the portfolio of 86 stocks that trade on an average of 12.5 times earnings compared to the 14.3 multiple of the broader smaller company market.
The managers’ preferred valuation measure is enterprise value (EV)/earnings before interest, tax and amortisation (ebita). Using this the portfolio trades on a multiple of just over 12 times, falling to 10.4 this year. By contrast, the 285 smaller stocks in Aberforth’s universe stand on a multiple of just over 14, forecast to fall to 12.8 in 2018 as earnings improve.
A quarter of the fund, which is a long-standing 'core' recommendation of Numis Securities, is held in stocks under £500 million. These smaller, small fry are even more cheaply valued, said Aberforth, and although they can be hard to trade, for an investment trust that need not be a forced seller, this was not a problem, the managers added.
‘Many investors are today nervous about illiquidity and are reluctant to commit to the stock market’s smaller denizens. ASL’s status as a closed-end fund allows it to take a longer term view, a strategy that paid off in 2017,’ the managers said.
Investors have spotted this potential already, with the gap – or discount – between ASL's share price and underlying net asset value narrowing to 10%, compared to the 13% average of the past year.
However, that is still cheaper than 10 of the 17 trusts in the AIC UK Smaller Companies sector.
Aberforth yields 2.2%, pays two dividends a year and over 10 years has trebled shareholders’ money with a 203% return. That beats the 182% from the Numis index but is about half the return from growth funds such as BlackRock Smaller Companies (BRSC), managed by Mike Prentis, and Standard Life UK Smaller Companies (SLS) under Harry Nimmo.
If recent stock market volatility is a prelude to a switch in investment styles rather than a boom and bust, Aberforth and its investors will hope that picture can be reversed.