Aberforth Smaller Companies 25 May 2022
This is a non-independent marketing communication commissioned by Aberforth Partners LLP. The report has not been prepared in accordance with legal requirements designed to promote the independence of investment research and is not subject to any prohibition on the dealing ahead of the dissemination of investment research.
Aberforth Smaller Companies (ASL) is one of relatively few options for value investing in the UK small cap space. While value was out of favour for many years prior to the pandemic, since then it has staged a comeback and ASL has performed strongly as a result (see Performance). While ASL has outperformed its benchmark and sector in 2022 year to date, this has been in a falling market. Perhaps as a result of general risk aversion, the Discount has widened to 16%.
ASL is team-managed using a disciplined style which has been honed since the trust launched in 1991. There is a seven-strong team of managers who operate within a collegiate structure intended to align the interests of shareholders and managers. The core aim is to identify companies which are trading at low valuations, ideally when their earnings are at cyclical lows too. The managers aim to hold until valuations reach fairer levels, and then sell out. Over the years this pragmatic approach has seen the team roll into and out of companies, building up knowledge and experience which can sometimes rival that of the companies’ management teams themselves.
The investment objective is to maximise total return, but the value discipline means the managers are led to companies with a higher yield than average. As we discuss under Dividend, the board had built rock solid reserves prior to the pandemic, which meant the dividend was raised in 2020 and 2021 despite the impact of the crisis on underlying revenues – and extensive reserves still remain. Considering the share price discount, the historic yield is now 2.8%.
ASL had the wind at its face for a number of years prior to the pandemic, but now looks very well situated in the current environment. Like the Sage of Omaha Warren Buffet, the team have stuck to their guns and implemented a disciplined value approach which has outperformed the index since launch and, following the return to form post-pandemic, over three-, five- and ten-year periods too, despite the significant outperformance of growth earlier on in these timeframes.
Value has typically outperformed growth in a rising interest rate environment and, given the pace of inflation, a hiking cycle looks likely to persist for some time. Furthermore, we have experienced a rapid deflation of a bubble in technology and ecommerce stocks akin to that we saw in 2000/2001, which we highlight below to have been a particularly good environment for ASL (see Performance). Additionally, the UK looks cheap versus international competitors with the impact of Brexit on valuations yet to be reversed.
We acknowledge that small caps are more volatile and may suffer more than large caps in a falling market, which may have led to the recent widening of the trust’s discount. Calling a bottom in the market is hard, and there may be more pain to come, but ASL’s discount of 16% looks attractive as a long-term entry point.
- Disciplined value strategy that has outperformed over long run
- Wide discount could prove good entry point
- Consistent approach should lead to more stable diversification benefits in a portfolio
- Strong style bias can lead to periods of underperformance
- Small cap focus could increase sensitivity if market falters
- Gearing increases sensitivity to falling markets as well as rising markets