Invesco Perpetual’s investment trust has fantastic track record of outperforming the market
Thursday 20 Jun 2019 Author: Daniel Coatsworth

All serious investors need a small cap fund in their portfolio and Invesco Perpetual UK Smaller Companies (IPU) is a cracker of an investment trust to buy now.

Smaller companies have the potential to generate high returns for investors as contract wins, a rise in customer numbers and market share gains can all have a bigger impact on their share price than larger, more mature companies.

Invesco’s fund has significantly outperformed the Numis Smaller Companies index benchmark over the past three, five and 10 years. Shareholders have been richly rewarded with 17.9% annualised total returns over the past decade, according to Morningstar. The ongoing charges figure is 0.88%.

HOW IT DIFFERS FROM THE REST

Co-managers Jonathan Brown and Robin West have plenty of experience investing in the smaller company space and they’ve differentiated the fund by having an enhanced quarterly dividend.

They initially targeted 4% yield but subsequent share price appreciation means the yield has fallen to 3.5% based on the amount of dividends paid in the past financial year. The majority of smaller company investment trusts have yields of 2.5% or lower.

The dividend is funded by a mixture of income from its underlying portfolio and capital.

The introduction of this enhanced yield has helped to improve market sentiment towards the fund and the shares are now trading on a narrower discount to net asset value, currently 2.9%.

PORTFOLIO CONSTRUCTION

Approximately one quarter of the portfolio contains stocks worth £1bn and above. Many of these holdings were smaller companies which have subsequently grown in size; it tends to sell down once they get bigger. One third of the portfolio is in the £500m to £1bn range; and most of the rest sit in the £100m to £500m range.

The managers look for companies with lots of growth potential. ‘We seek good profit margins, good returns, some pricing power or barriers to competition. Intellectual property and good brands are also desirable,’ says West.

‘We don’t look at blue-sky companies,’ he adds, referring to businesses which might have a bright idea but are not yet generating a profit. ‘We want companies where we can analyse historic returns to see if margins have held up.’

Most of the analysis is done by the Invesco team with third party research used to help build financial models.

The managers undertake hundreds of company meetings and site visits a year, and Brown and West make sure they go together rather than splitting these meetings up.

‘You get a more thorough analysis when two people  attend a meeting,’ says West. ‘We can be more fleet of foot, as we can make a decision on whether to invest straight after a meeting, rather than one of us having to brief the other about what was said.’

PORTFOLIO THEMES

The two biggest themes in the portfolio are roll-ups/roll-outs where companies are either buying rivals or expanding organically to gain scale, and stocks offering growth at a reasonable price (GARP).

Among the former, positions include tenpin bowling operator Hollywood Bowl (BOWL), document management group Restore (RST:AIM) and IT infrastructure provider Softcat (SCT).

Johnson Service was snapped up when the managers realised the market misunderstood the company. ‘People thought it was just a dry cleaning business, so it was priced at a discount. The shares benefited from the discovery effect as more people began to appreciate it had morphed into something much bigger in textile rental and linen services.’ Shares in Johnson Service have nearly tripled in value in the past five years.

Polypipe (PLP) features among Invesco’s GARP selections. Manufacturing pipes may be as dull as it can get, yet that’s exactly what attracted Brown and West to the stock.

Many investors looking for exciting, market disruptive stories wouldn’t give Polypipe the time of day which mean other investors had a chance to buy into an underappreciated story when it floated on the London market in April 2014 at 245p. Today the shares trade at 430.6p.

‘Polypipe may appear to be a basic business but it has scale, is investing in factory automation and has an advantage with builders’ merchants. The latter want to offer a full range of products to trade customers but they don’t have room to take a lot of stock,’ explains Brown. ‘They are able to give a good service and replenish stock quickly, which smaller rivals can’t do.’

Other types of investments in the fund include self-help or recovery situations and companies benefiting from structural growth. The latter includes promotional products group 4imprint (FOUR) which recently qualified for inclusion in the FTSE 250 index, so perhaps no longer considered to be a smaller company.

West says it is the market leader in the US but only has a 3% market share, implying further opportunity for growth. He adds that 4imprint has benefited from expanding marketing spend across          more channels.

A year ago Google told the company it couldn’t see a go-to-name in promotional products from an advertising perspective. It suggested 4imprint try radio and TV advertising, as well as online. The returns from 4imprint following Google’s advice beat expectations.

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