The investment trust on a quest for growth and value
One of the largest and most liquid UK smaller company trusts, yet trading at a 10.2% discount to net asset value (NAV) that suggests value abounds, Henderson Smaller Companies (HSL) has been successfully managed by trained accountant Neil Hermon since 2002.
Hermon has established a formidably strong long-term track record by constructing a diversified portfolio with a focus on growth at a reasonable price (GARP).
In fact, the trust has delivered NAV total returns of 416% or 17.8% per annum over the last ten years. That compares with 225% (12.5% per annum) for the benchmark Numis Smaller Companies ex Investment Companies Index.
Admittedly, Henderson Smaller Companies marginally underperformed the index in the year ended 31 May 2019, but this was only the second year in the past 16 that Hermon has underperformed.
Cushioning the blow was a 9.5% hike in the total dividend to 23p, underpinned by the quality of portfolio companies’ earnings and marking an impressive 16th consecutive year of dividend growth.
GOING FOR GARP
Henderson Smaller Companies aims to maximise shareholders’ total returns by investing in UK-quoted smaller companies, defined as any company outside the FTSE 100. Once a portfolio company enters the FTSE 100, Hermon (in normal circumstances) has six months to sell the stock.
Ably assisted by Deputy Fund Manager Indriatti van Hien and analyst Shiv Sedani, Hermon has an unwavering emphasis on finding quality growth businesses via bottom-up stock selection. The investment style aims to seek ‘quality growth at the right price’, which involves focusing on businesses with ‘good growth prospects, sound financial characteristics and strong management, at a valuation level that does not reflect these strengths’.
The portfolio is reassuringly well diversified with over 100 holdings. The largest position, asset manager Intermediate Capital (ICP), accounts for a modest 3.4% of assets.
The fund’s universe for new purchases is stocks in the bottom 10% of the UK stock market and Hermon tends to focus on the larger more liquid stocks in the universe. The manager is willing to run his winners, although he will top-slice positions in order to maintain portfolio diversity.
As a result, 62% of the portfolio is currently in FTSE 250 stocks, among them housebuilder Bellway (BWY) and infrastructure projects powerhouse John Laing (JLG), with the remainder split between FTSE Small Cap (21%) and AIM stocks (25%).
CHAMPIONING GROWTH COMPANIES
Hermon is willing to help fund the growth prospects of selective stock market newcomers, with the trust having participated in a number of IPOs.
Recent positions opened in more established market names include property agent Savills (SVS), oil and gas play Serica Energy (SQZ:AIM) and Vitec (VTC), a leading manufacturer of specialist camera/video accessories, lighting and sound equipment.
‘Savills is a real estate services company offering retail and corporate sales, valuation, fund management, property facilities and consulting for a broad range of clients across Europe, America, Asia and Australia,’ says Hermon.
The business has been significantly diversified over the years, ‘reducing its exposure to transactional services towards more predictable revenue streams.
‘Our investment in Savills provides us with a quality, diversified real estate business with a strong management team and opportunities for expansion through tactical acquisitions.’
Vitec has ‘a high market share in each of its product categories and continues to outperform its peers through new product innovation’, according to the small caps guru.
‘Whilst the consumer camera market has shifted to the use of mobile phones, there still remains an active professional and amateur photographer market that buys high quality equipment.
‘Our investment in Vitec provides exposure to a company with an improving demand cycle, increasing margins through efficient manufacturing and the potential for small acquisitions of other niche brands.’
Hermon has sold companies which he felt were set for poor price performance, including Elementis (ELM), ‘a speciality chemicals group where the company made a poorly judged and expensive acquisition of Mondo Chemicals, an industrial talc company. This boosted leverage to levels we were uncomfortable with’.
Turning to the outlook, Hermon points out the UK economy is showing anaemic growth. ‘Brexit deliberations stumble on and there is clearly a range of outcomes but what deal, if any, the UK will end up with is, at this point, unclear.
‘Extra complication is added by the political uncertainty in the UK that is likely to weigh on consumer and business confidence, and delay and postpone investment and purchasing decisions, further dampening economic growth.’
Outside the UK, Hermon notes that ‘Europe in particular is showing signs of economic slowdown and escalating trade tensions between the US and China are providing additional negative commentary.’
Yet Hermon stresses that ‘conditions in the corporate sector are intrinsically stronger than they were during the financial crisis of 2008-9. Balance sheets are more robust and dividends are growing.’
In addition, ‘a large proportion of UK corporate earnings come from overseas, even among smaller companies, and should be boosted by the relative weakness of sterling. With regards to valuations, the equity market is now trading below long-term averages and M&A remains a supportive feature for smaller companies.