Invesco Perpetual UK Smaller Companies 05 June 2023
Disclosure – Non-Independent Marketing Communication
This is a non-independent marketing communication commissioned by Invesco Perpetual UK Smaller Companies. 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.
Managers Jonathan Brown and Robin West aim to generate top-quartile returns for Invesco Perpetual UK Smaller Companies Investment Trust (LON:IPU) across the economic cycle, with lower volatility than the peer group average. This is achieved through a stock selection process which aims to buy quality companies at attractive valuations, chosen through a bottom-up stock selection process. The managers have adopted a barbell approach to achieve this, which involves holding a blend of quality companies, trading at reasonable valuations with visible earnings growth, and cyclical names that are trading at cheap valuations but which have scope for a rerating (see Portfolio).
After years of gloom, the managers believe the negativity surrounding the UK may be starting to lift. To reflect this, the managers are now fully invested and may begin to utilise Gearing. They have exercised more buys than sells in the past six months, which they believe indicates not only a better outlook than the media would have us believe, but also attractive valuations. They admit there may be short-term concerns, but historically, these valuation levels have led to strong returns in the subsequent 12 and 24 months (see Performance). Long-term performance has been strong and, after a wobble, the managers have returned to the top quartile against peers in 2023. The managers highlight that the market has been very focussed on macro factors recently and not been considering fundamentals, which has provided them with a number of opportunities.
IPU also pays a 4% Dividend with support from capital, which allows the managers to focus on companies rather than yield. Underlying income generation has been better than expected, which improves the overall total return opportunity for investors.
We believe IPU offers an attractively rounded approach to smaller companies. Smaller companies tend to outperform over the long term, though they are often perceived as being higher risk, but IPU’s approach should provide relatively low risk access to the sector. The barbell approach (see Portfolio) continues to offer defensiveness, yet the managers’ stock selection capabilities, demonstrated by strong long-term returns , continue to offer the prospect of alpha generation. As such, we believe the trust may suit more risk-conscious investors who like the long-term attraction of the asset class, supported by an attractive Dividend yield.
We think UK smaller companies increasingly seem to have attractive prospects (see Performance). The managers are increasingly confident in the outlook for UK smaller companies, having moved to being fully invested and looking at the potential of adding Gearing. We believe the UK may well be at a turning point, but remains deeply undervalued. We observe the recent uptick in M&A activity, which may prove a potential catalyst. Despite this, valuations remain low and, historically, this level has proved fortuitous for investors. We believe this attraction is enhanced by the wide Discount the trust is trading at. It has widened to one standard deviation below the five-year average and is in line with the sector average, despite previously trading considerably narrower. If any combination of robust company fundamentals, a better-than-expected economic outlook or sustained M&A activity begin to cause a market recovery, we believe IPU could be well-positioned to capture this over the next economic cycle. However, this would be in a relatively low-risk way per the trust’s investment process.
- Valuations for the small-cap market remain very attractive
- Lower volatility approach offers defensiveness
- Trust is trading at a wide discount versus its own history and relative to peers
- Managers are fully invested having long been cautious on allocations
- Short-term underperformance is affecting long-term track record
- Risk-conscious approach may limit potential upside