Smaller companies for life, not just for Christmas
- The rising tide for smaller companies has flattered some weaker companies
- However, the ‘dash for trash’ is now drawing to a close
- Our analysis suggests investors are now starting to prioritise those companies with more predictable and enduring earnings
This has been a bumper time for UK smaller companies. Buoyed by economic recovery, they have outpaced their larger peers. However, this rising tide has lifted all boats, flattering weaker smaller companies as well as those of higher quality. We believe investors will need to be discerning as the first flurry of recovery fades.
The early stages of a recovery are often a good time for smaller companies, with share prices pushed higher by a revival in earnings. Weaker companies, where earnings have suffered most during the pandemic, have done particularly well – their share prices had fallen further and they have therefore benefitted most from the recovery.
This is often characterised as a ‘dash for trash’, where investors look to take advantage of recovery in those companies hit hard during a period of weakness. They are a common phenomenon during periods where expectations for the economy and markets are turning, usually lasting around six months.
We have now seen three proper ‘dash for trash’ value rallies during the life of Standard Life UK Smaller Companies Trust: April to September 2003, March to August 2009 and November 2020 to March 2021. Our investment process means that we always underperform these rising markets. The trade-off is greater resilience when markets are falling, as we saw in 2020.
The problem for these weaker companies comes after the short-term recovery is over. While they may see their earnings recover in the short-term, they have not become better companies. Many of these companies will struggle to grow their earnings sustainably as the economic recovery matures.
Our analysis suggests that this ‘dash for trash’ rally is already drawing to a close. The market has once again started to prioritise those companies with a more predictable and enduring earnings stream. For the Trust, this is music to our ears. We focus on high quality companies displaying strong growth and momentum and this should be a time when those characteristics are appreciated by the market.
Certainly, we are seeing strength in earnings. Recent results from many of our holdings have come in ahead of expectations, such as Future, a media company and our largest holding, plus other top ten stocks Gamma Communications(telecoms), DiscoverIE (electronics) and Focusrite (techno-music). We have also seen recent trading statements from Impax (a specialist asset manager) and Robert Walters (recruitment) that were significantly ahead of expectations.
To ‘lean in’ to this shift in market conditions, we have increased the level of gearing in the Trust. This now sits at around 6% (to 30 June 2021). This is a key advantage of the investment trust structure and we believe it is important to use it where we see opportunities.
Big versus Small
The top half of the UK’s larger companies index, the FTSE100, does indeed have a “last century” feel about it with many companies and sectors like Banks, Mining, Utilities and Oil & Gas where growth is hard to find. However in small and midcaps the position is much more vibrant and healthy featuring growing sectors such as Software, Financial Services, Media and Leisure Goods. All these sectors are internet enabled and at the forefront of digitalisation. Good examples would include AJ Bell, the investment platform and Team17 in computer games.
The Alternative Investment Market (AIM) has really come of age and is now the envy of the world for showcasing the best of British smaller companies. The upper reaches of this market brings a diverse mix of profitable growth companies with many paying dividends; a far cry from ten years ago.
The IPO market has come alive in 2021, with a number of exciting smaller, dynamic businesses coming through which are also founder-run. We like that. IPOs can be a fertile area for new long term ideas, with JTC in fund administration and Kainos (digitalisation) being success stories for the Trust that remain large positions. We have bought Auction Technology, Trustpilot and BIG Technologies into the portfolio this year. The IPOs market is however an area where it is important to take care over stock selection.
We often identify companies that have become successful in the UK but that show breakthroughs abroad. A small niche can become really large if a UK company is successful worldwide. Good examples of this include Games Workshop In tabletop games, GB Group in ID verification software and Hilton Foods in specialist grocery category management for example.
We believe that a company’s environmental, social and governance (ESG) credentials will become increasingly important to investors. As such, building this into our process is vital for the long-term resilience and sustainability of our holdings. Smaller companies tend to have less external ESG research coverage. We do this in-house, using our own fundamental research to identify issues and add value. We also hold a number of companies actively making an ESG impact – the aforementioned Impax Asset Management and Draper Esprit, a venture capitalist firm, for example.
The ‘dash for trash’ rally has not distracted us. We want to find those companies whose strength will last far longer than the next few months when economic recovery has greatest momentum. We want companies for life, not just for Christmas.
© owned by each of the corporate entities named in the respective logos. Companies selected for illustrative purposes only to demonstrate Aberdeen Standard Investments’ investment management style and not as an indication of performance.
Risk factors you should consider prior to investing:
- The value of investments and the income from them can go down as well as up and you may get back less than the amount invested.
- Past performance is not a guide to future results.
- Investment trusts are specialised investments and may not be appropriate for all investors.
- There is no guarantee that the market price of a Trust’s shares will fully reflect its underlying Net Asset Value.
- As with all stock exchange investments the value of the Company’s shares purchased will immediately fall by the difference between the buying and selling prices, the bid-offer spread. If trading volumes fall, the bid-offer spread can widen.
- The Company may borrow to finance further investment (gearing). The use of gearing is likely to lead to volatility in the Net Asset Value (NAV) meaning that any movement in the value of the company’s assets will result in a magnified movement in the NAV.
- The Alternative Investment Market (AIM) is a flexible, international market that offers small and growing companies the benefits of trading on a world-class public market within a regulatory environment designed specifically for them. AIM is owned and operated by the London Stock Exchange. Companies that trade on AIM may be harder to buy and sell than larger companies and their share prices may move up and down very sharply because they have lower trading volumes and also because of the nature of the companies themselves. In times of economic difficulty, companies listed on AIM could fail altogether and you could lose all your money.
- Certain Companies treat the generation of income as a higher priority than capital growth; such Companies may deduct part or all of their management charge from capital. This will increase the amount of income available but at the expense of capital growth.
- Shares of smaller companies may be more difficult to buy and sell than those of larger companies. This means that the Investment Manager may not be able to buy and sell at the best time or may suffer losses. This could reduce your returns.
- Companies selected for illustrative purposes only to demonstrate the investment management style described herein and not as an investment recommendation or indication of future performance.
Other important information:
Issued by Aberdeen Asset Managers Limited which is authorised and regulated by the Financial Conduct Authority in the United Kingdom. Registered Office: 10 Queen’s Terrace, Aberdeen AB10 1XL. Registered in Scotland No. 108419. An investment trust should be considered only as part of a balanced portfolio. Under no circumstances should this information be considered as an offer or solicitation to deal in investments. You should obtain specific professional advice before making any investment decision.