Invesco Perpetual UK Smaller Companies 27 May 2022

Invesco Perpetual UK Smaller Companies (IPU) is relatively distinct in the peer group in that the managers employ a process aiming to deliver a strong performance over the long term but with below-average volatility. The consistent way in which they apply their investment process is crucial, having led to strong outperformance of the benchmark and peers over the years whilst having amongst the lowest NAV volatilities of the peer group.

In seeking to achieve this pattern of returns, IPU’s managers pay plenty of heed to portfolio construction, leaving it capable of performing across varied market conditions. This explains their current barbell approach (see Portfolio section), with exposure to both higher-rated growth stocks as well as those which the team believe are fundamentally undervalued. At the same time, their valuation-led stock-picking leads the managers to regularly recycle capital from investments that have performed the best into those stocks which are looking more attractively valued.

The adoption of a new benchmark (the Numis Smaller Companies + AIM excluding Investment Companies Index) from the start of the current financial year does not mark a significant change. Historically, around 30-35% of the portfolio has been invested in AIM over the past few years, which prior to this year would have represented an off-benchmark exposure.

The board’s policy is to pay quarterly dividends that, in aggregate, amount to 4% of the financial-year-end share price, mathematically resulting in changes in the actual dividend paid each year. This policy should ensure that the dividend yield will likely remain attractive on a relative basis when compared to the peer group, which currently offers an average yield of 2.3%.

Current market conditions are revealing the same pattern of widening discounts in UK smaller companies trusts that we have seen in the past. At the time of writing, IPU is trading on a discount to NAV of 17%, which compares with the average over the past five years of 7.4%. The board do have permission to buy shares back, but with the board effectively returning around 2% of capital per year already, through supporting the annual dividend, we think it unlikely the board will step in whilst market conditions remain volatile.

Whilst the current outlook is very unclear, the managers appear firm in their convictions on underlying earnings for portfolio companies. The team’s focus on ‘quality’ companies means they can potentially continue to grow irrespective of the economic environment. The historic level of takeover activity in the portfolio gives credence to the fact that these companies are in demand from long term investors. The fact that GBP has depreciated so rapidly against the USD means further M&A cannot be ruled out.

We believe the new benchmark, whilst not precipitating a huge change, will give the managers confidence to continue to look for opportunities at the smallest end of the market capitalisation spectrum. Historically, the team have had good success here, and with a new market cycle potentially developing, this could be helpful to long term returns. The current discount to NAV offers investors a potentially interesting entry point.