Brown Advisory US Smaller Companies 08 December 2023
This is a non-independent marketing communication commissioned by Brown Advisory. 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.
Brown Advisory US Smaller Companies (BASC) aims to provide investors with a core US small-cap holding, with a risk-controlled approach emphasising compounding returns over the long term. BASC is managed by Chris Berrier, who has been managing similar strategies for Brown Advisory for over 18 years, and could be considered the architect of the philosophy behind them. Chris is supported by associate portfolio manager George Sakellaris, and overall Brown Advisory has c. 40 equity analysts providing the team with insights. The team manages c. $6.3bn in similar strategies to BASC.
The team focus on quality growth companies and valuation, which translate to typical portfolio characteristics of lower debt, higher return on capital and higher growth prospects than the average for the benchmark. Although US small-caps have underperformed large-caps more recently, the team has a long-term track record of outperforming the benchmark, which itself has outperformed US large-cap equities over the long term.
Brown Advisory was appointed to manage the trust at the end of March 2021. Since then, market conditions have not been favourable for US small-cap equities, but nevertheless the team’s strategy has outperformed the benchmark, with the NAV declining 7.0% compared to a 8.5% decline for the benchmark to 27/11/2023. Against a backdrop of unfavourable markets and widening investment trust discounts, BASC’s discount has widened to c. 13 %, compared to its five-year average of c. 11%.
The board has recently amended its share buyback policy, committing to using share buybacks to reduce discount volatility and working to reduce any discount should it become significantly wider than those of similar investment trusts. The board has not bought back any shares during 2023.
As is the case for UK smaller companies, historical data shows that US smaller companies tend to outperform large-caps, and perform well in absolute terms, when rising interest and inflation cycles start to peak and reverse. This is, at least in part, because the precursor to that particular set of conditions usually involves quite negative sentiment, which leads to very low valuations. Analysis that Chris and the team have undertaken shows that US small-caps, with both a growth and a value bias, are trading at very low valuations compared to history as well as to large-caps. If one needed further validation that sentiment is very negative, BASC’s own discount of c. 13% is part of a wider trend across the investment trust sector that is partially explained by negative sentiment.
Over the long term, investors in investment trusts would no doubt like to see BASC deploying modest gearing, and indeed the board notes that it is cognisant that this is one of the advantages of the investment trust structure. Negative markets since Brown Advisory took on the mandate, however, validate the decision not to gear in the short term. It is of course impossible to pinpoint in advance the moment when the cycle for US small-caps will change, but in the meantime, the long-term investor may find the combination of low underlying valuations and a wide discount appealing.
- A steady, risk-controlled approach in an asset class that can be volatile
- Wide discount to NAV compared to historical average
- US small-caps are trading at very low valuations compared to history
- Does not pay a dividend
- Interest rates may stay higher for longer, providing a headwind
- Smaller companies can be riskier than large companies