Fund Profile

Montanaro UK Smaller Companies 28 July 2023

Disclaimer

Disclosure – Independent Investment Research

This is independent research issued by Kepler Partners LLP. The analyst who has prepared this research is not aware of Kepler Partners LLP having a relationship with the company covered in this research report and/or a conflict of interest which is likely to impair the objectivity of the research and this report should accordingly be viewed as independent.

Overview
2022 was a perfect storm of headwinds for MTU. Will the stock picking prowess deliver a recovery..?
Overview

Manager Charles Montanaro is in his second period of managing Montanaro UK Smaller Companies (LON:MTU) and focusses on UK smaller companies using a quality growth approach. He has access to an in-house specialist analyst team to help him identify under researched opportunities, which are often companies that are industry leaders offering long-term structural growth, and then holding them for the long term. Whilst Charles focusses on achieving capital growth when selecting stocks, the board has a Dividend policy of paying 1% of NAV every quarter to increase the attractiveness of the trust.

Charles also has a strong ESG ethos, which is built into both the trust and the wider firm. For MTU, this means that certain sectors, such as energy, are excluded. Additionally, Charles takes a straightforward approach of only buying companies with understandable business models. This means that over-complex industries, such as financials which are difficult to forecast, are often overlooked. Conversely, Charles looks for quality factors from companies with the ability to grow which is likely to lead to pronounced overweight and underweight positions, and a tilt towards the growth style of investing (see Portfolio).

This has had an impact on recent Performance and higher interest rates have been a headwind for growth stocks. However, Charles believes the low interest-rate environment will return to the UK due to structural issues, and then his stock-selection approach should be able to deliver outperformance of the index.

Analyst's View

Whilst neither paying a dividend from capital nor investing in growth companies is uncommon in the populous AIC UK Smaller Companies sector, we believe MTU’s blend of both helps set it apart. It offers investors the ability to access the numerous capital growth opportunities, with an attractive income to complement it. However, this growth style has faced headwinds recently and while veteran manager and company founder Charles Montanaro believes this will reverse, the trust’s exposure has impacted short-term Performance.

We believe this impact has been more pronounced because of the avoidance of complex sectors, such as banks and the ESG criteria. This means that the trust is unlikely to hold stocks which would diversify the growth bias in the stock selection process.

However, these recent performance headwinds have led to the shares widening to a Discount. Whilst this is not uncommon over the longer-term history of the trust, it is wide compared to historical levels since the trust implemented the dividend policy. This may be seen as a valuable opportunity, especially if the headwinds to the trust subside.

We believe that the team at Montanaro (see Management) are also a positive. They are specialists in the area and have a disciplined, proven research process which can capitalise on the under-researched smaller company sector. As such, we believe Charles should be able to benefit from superior stock selection over the long term. However, the inherent biases in the approach mean it is exposed to the market preferences towards his investment style.

Bull

  • Growth focus, but with income generation built in
  • Specialist and well-resourced analyst team
  • Both UK smaller companies and the portfolio are cheap versus their respective histories

Bear

  • Growth bias could struggle in a value rally
  • Concentrated portfolio means NAV may be more volatile than peers
  • Gearing can exacerbate the downside
Continue to Portfolio

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