Using investment trusts to access smaller companies in the US

We talk to JPMorgan, Jupiter and North Atlantic about the opportunities
Thursday 07 Dec 2017 Author: Lisa-Marie Janes

Many investors will be familiar with the range of smaller companies on the UK stock market, but how well do you know small caps listed overseas? Using investment trusts is an easy way to access exciting companies lower down the market cap spectrum as the fund managers do the hard work finding the best opportunities.

We’ve spoken to fund managers at three investment trusts which specialise in finding small cap opportunities in the US. Read on to discover some of their favourite stocks and why they have a place in the respective portfolios.

Potential tax reform set to boost small caps

Smaller companies have historically been very good investments, offering the potential to deliver greater returns than their larger counterparts, albeit with higher risks.

JPMorgan US Smaller Companies Investment Trust (JMI) portfolio manager Don San Jose invests in well-run firms with ‘attractive and sustainable profits’ to provide capital growth. Jose aims to own equity stakes in businesses trading at a discount to their intrinsic value.

He believes the backdrop for US small caps has changed throughout the year as potential tax reform and good economic growth could have a bigger impact for these firms compared to larger businesses.

‘Both have an impact on small caps, given their higher effective tax rates and their domestic focus,’ comments San Jose.

The fund manager says landscape equipment business Toro is attractive as it derives over 30% of its current sales from new products. He is optimistic the company has a lot more to offer as it has the flexibility to make strategic acquisitions in a competitive space.

According to San Jose, Toro has a good track record of meeting long-term targets to generate consistent sales and earnings growth thanks to its experienced management team.

Medical delivery devices manufacturer West Pharmaceuticals Services is another of his top picks. ‘The company has a high market share and is able to generate stable and growing operating cash flow,’ says the fund manager.

Looking for long-term capital growth

Jupiter US Smaller Companies (JUS) aims to achieve long-term capital growth through a diversified portfolio, including listed smaller and medium sized businesses in the US.

Fund manager Robert Siddles seeks out stocks unfairly punished by the market and keeps an eagle eye on those that have potential for at least 50% share price appreciation, should there be catalysts for a re-rating.

He is excited by The Chefs’ Warehouse, a distributor of upmarket food to restaurants. ‘Distribution businesses are good free cash flow generators because of their high proportion of fixed costs,’ says Siddles, who highlights The Chef’s Warehouse delivered $23m in free cash flow last year.

Metal working supplies distributor MSC Industrial Direct Holdings is another attractive prospect for the fund manager. MSC is the market leader with sales of $3bn in a crowded market of 150,000 distributors.

‘Decades of investment and a large technical sales force give the company its edge and its “Big Book” is well known in the industry,’ comments Siddles.

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The shares have been suffering this year as investment put margins under pressure and pricing weakened due to the impact of the recession in the energy sector since 2014 on US manufacturing.

Despite the underperformance on the market, MSC is not expected to remain depressed for long, with Siddles expecting the distributor’s margin to improve as investment winds down.

He is optimistic that US manufacturing will continue to improve thanks to a recovery in the energy sector, driven by better oil prices.

It is worth noting that MSC is worth $5.1bn which isn’t exactly what you would call a ‘smaller’ business. Many small cap funds, including those in the UK, do invest in companies of such size. Anyone wanting the real tiddlers should look for funds which specialise in an area called ‘micro caps’.

Proactive investment style

North Atlantic Smaller Companies Investment Trust (NAS) focuses on capital appreciation though a portfolio of smaller firms based in countries that border the North Atlantic Ocean.

Fund manager Christopher Mills has a proactive investment style as he takes large stakes in the firms he invests in and gets involved.

A lot of his portfolio contains UK-listed stocks yet there are some US ones. Earlier this year the investment trust said it was significantly under-invested in the US due to valuations being very high by historical standards.

Of the US stocks that do sit in his portfolio, Mills is particularly excited by Ambac Financial which he says is currently trading at a 50% discount to its intrinsic value, as the impact of the firm’s nearly $2bn insured exposure to Puerto Rico’s debt weighs on sentiment. (LMJ)

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