Aberforth Smaller Companies Trust (ASL) invests in UK small-caps with a disciplined value investment style. While its portfolio has been under pressure in 2020, the announcement of good results from a candidate vaccine in late October saw its NAV rally and share price rally even harder than the market, which the managers believe indicates strong rebound potential.
ASL has been managed to the same style since launch in 1990 and has outperformed the Numis Smaller Companies ex IT Index by over 1.5% p.a. since then according to Morningstar data (c. 56% cumulatively). With value falling out of favour in recent years, ASL’s returns have been positive but behind the index and ‘growthier’ peers.
In common with other value portfolios around the world ASL’s portfolio has a strong cyclical tilt, which means its companies have seen their earnings put under pressure by lockdowns and the accompanying recession. However, as we discuss in the Performance section, the Pfizer vaccine announcement saw a sharp pop of absolute and relative performance which may indicate the performance potential once the recovery comes. The discount has since halved to 6.3%.
ASL has only taken on significant gearing on three other occasions (see Gearing section) but, in response to the extreme valuations in the market and the portfolio, the managers have brought net gearing up to 7% and have the facilities to double this.
Aside from total-return potential, ASL is also in a strong position with regards to the dividend. The board entered the year with 2.4 times last year’s dividend in reserve and raised the interim pay out by 4% in July. The yield is 3%.
We think it is highly significant that the investment team at Aberforth have taken on meaningful gearing in the aftermath of 2020’s market crash. This is a rare occurrence in ASL’s thirty-year history and has previously preceded strong market returns. We agree with the managers that a lot of the pieces are in place for a cyclical recovery in the UK once the pandemic has passed and Brexit has been resolved. While the immediate few months could see twists and turns in both matters, we think the sharp rally in recent weeks in value, in small-caps and in UK stocks as a whole shows that the elastic has been pulled taut and, as the managers put it, the risks to the upside have seldom been greater.
Notably, the rebound potential does not necessarily require a rebound of value vs growth. A rerating of the whole market to pre-COVID-19 valuations and a normalisation of earnings would do the trick, as we discuss in the Portfolio section. The potential for value to outperform growth is another potential tailwind for the coming years. We think it may require an initial cyclical recovery first in order to generate a rising interest rate environment - although there is the potential for high growth stocks to sell off on the anticipation of this given how far they have outperformed in recent years.
|Cyclical bias to portfolio which could perform very strongly in a post-COVID-19 recovery||Low-rate environment could be unhelpful for value in the medium term|
|Valuation of UK market and portfolio versus the market at extreme lows
||There are risks to the UK from a bad Brexit and a relapse of the pandemic
|Very high dividend reserves, with the dividend likely to be grown through the crisis
||Gearing increases sensitivity to falling markets as well as rising markets