Standard Life UK Smaller Companies Trust plc

An update from our investment manager, Harry Nimmo - 14 October 2020

The resurgence of Covid in a second wave, if anything, has been helpful to our Matrix led, Quality, Growth and Momentum process. In essence, the trend towards cyclical recovery has been postponed for the time being. The sector winners and losers tend to be the same as in the previous three to six months. The beneficiaries have been in sectors like leisure goods, media, financial services, telecoms, software and healthcare. Some support service, construction and industrial sectors have also seen some recovery. Many of the constituents of the aforementioned sectors have reinstated their dividend along with upbeat trading statements. Weaknesses have been in transport & leisure, real estate, oil & gas, retailers and mining. Food manufacturing, while trading well has seen some profit taking since the early days of Covid.

Within the fund, the standout sector has been leisure goods where Games Workshop, Team17 and Focusrite in hobby games, computer games and techno-music kit have traded strongly given they have been well suited to the social distancing environment. Financial services, particularly fund administration (Sanne, JTC), wealth management (Mattioli Woods, Impax, Brooks Macdonald) and asset platforms (AJ Bell, Integrafin) have all adapted well to working from home and the strong recovery in equity markets. Likewise, software is well suited to remote working and in particular the continued trend toward digitalisation (Kainos, First Derivatives, GB Group and FDM). Media has fared well under Covid with the current crop of companies generally having better visibility of earnings. These would include Future plc, GlobalData and YouGov. Our telecoms stocks have remained in good shape - Gamma Communications in particular has performed well whilst providing services to those working at home. In the large support services sector it has been a more mixed picture with language translator RWS, Diploma in specialist distribution and Alpha FMC in consultancy having prospered, while Ricardo (auto engineering), Robert Walters (recruitment) and Midwich (audio-visual technology) have struggled. In electronics, XP Power in power converters recently came out with a strong trading statement and DiscoverIE in electronic subsystems has also been trading well. It is also the case that many of the above companies are upgrading forecasts and reinstating their dividends. 

There are however seven holdings making up about 8% of the fund that have continued to be impacted by Covid-19. These stocks are generally in leisure and restaurants or food to go. They are Jet2, Trainline, 4imprint in sales promotion, Hotel Chocolat, Greggs, Workspace and Hollywood Bowl. The good news is that these companies have strong balance sheets and we believe that they will see out an extended lockdown, coming out the other side able to gain share from weaker competitors. Counter-intuitively the fund is overweight real estate, a sector being hit hard by Covid. The two self-storage businesses; Big Yellow and Safestore have continued to trade well, as has Sirius Real Estate who own and manage mixed industrial space in Germany. Workspace, the managed work centre company, however, is seeing tenants under pressure. It does however have a robust balance sheet. The fund does not invest in oil & gas, mining, industrial minerals and chemicals - sectors that remain under intense pressure. 

My view is that the 19th March was the turning point for markets and indeed the early recovery phase in what is normally a very strong period for economically sensitive small-caps.  A major trend has also been the resurgence of technology stocks through digitalisation, the facilitating of working from home, cloud computing, digital media and online retailing. In the US, it is the FAANGs that have led the charge. In the UK, it is the Alternative Investment market (AIM) that is at the forefront. AIM has come of age with a majority of the leading companies in growth mode with strong profit generation and many of them paying dividends. They are in general the new businesses that have benefitted from the work from home, social distancing Covid environment.  The leading AIM stocks are made of the UK’s most innovative growth stocks with the top ten including ASOS, Fevertree Drinks, Keywords Studio, Gamma Communications, Abcam and GB Group. It is no wonder that AIM (+3.7%) has massively out-performed the FTSE100 (-20.4%) year to date as well as the FTSE Smallcap (ex-IT) (-19.8%) and (-17.0) indices. (numbers are to 13/10/20, source Bloomberg).

The current environment of major monetary and fiscal stimulation and incredibly low interest rates remains positive for equities and smaller companies in particular. At some stage, however, there will be a resurgence of the cyclical elements in the market, when an end to Covid becomes clear. At that point, our quality, growth and momentum process will under-perform a rising market for a number of weeks. This does not detract from the veracity of the process. We have been through four market cycles and we know that our investment process remains valid into the future. I remain most positive about smaller companies and our investment process.