Aberforth Smaller Companies 30 April 2019

Aberforth Smaller Companies (ASL) is the only UK smaller companies trust with an unambiguous value approach, barring its income-focused sister Aberforth Split Level Income.

The long-term track record has been extremely strong, although returns in recent years have been below those of the peer group thanks to the managers’ diligent adherence to a value approach - a style that has been very much out of favour in what has been a growth or momentum driven market. The value approach and the concentration on the smaller end of the market (due to its lower valuations) differentiate the trust from its peers.

The value approach leads to a contrarian tilt to the portfolio, which has in recent years become overweight domestic earners and picked up exposure to resilient retailers that have been sold off on sentiment rather than fundamentals. These exposures have helped the trust in recent months.

The team of managers has extensive experience, with the two remaining founding partners having been involved in running the portfolio since 1990. One of them, Richard Newbery retires at the end of this month (April 2019), leaving a committed team of six experienced investors who follow the same philosophy and approach the company has had since the beginning. The team has significant shareholdings in the trust, and so their interests are well-aligned with the long-term interests of shareholders.

Although the trust aims for total returns, the value approach often leads the company into higher dividend-payers. The historic yield is 2.4% excluding non-recurring special dividends, which compares favourably to a sector average that does include specials of 2.5%. The board is committed to a progressive dividend policy, which has been supplemented by special dividends over recent years. With significant revenue reserves and high average cover for dividends paid by the portfolio holdings, the managers hope that the dividend can grow even through the next cyclical downturn.

The trust is trading on an 8.7% discount compared to a sector average of 7.2%. The trust did trade on a tighter discount than the sector briefly in Q1. In this period many investors bought back into the UK on value grounds, although after the date for “Brexit” was pushed back into the autumn the discount widened again.

The strict valuation discipline makes this trust unique in the smaller companies space. We believe it could be held on its own by investors who wish to harvest the value premium in small caps, or used to diversify the heavy growth biases in most small- and mid-cap focussed funds, open- or closed-ended.

Value has been out of favour for a while in small caps and in the wider market thanks to the low growth, low inflation environment, which has seen investors chase secular growth in the few areas they can find it. A period of rising rates and inflation could create a much more fertile ground for Aberforth’s approach, although we note that calling turns in the market is extremely difficult, so waiting for a regime change could be a risky approach to take. Thanks to the aversion to the value style, the trailing PE on the Aberforth Smaller Companies portfolio is towards its lowest at any time since launch, except during the early 1990s recession and immediately following the 2008 crisis.

Moreover, the 9% discount perhaps offers some comfort on the downside. A rebound in the performance of value versus growth could well see the trust trade on a premium versus peers as has happened in the past.