Scottish Oriental Smaller Companies 01 December 2021

Scottish Oriental Smaller Companies (SST) aims to identify high-quality Asian businesses with market-leading positions and strong balance sheets which can grow faster than the market over the long run. The strategy has a track record of generating good returns after global economic crises. As we discuss in Performance, it has done well in 2021 so far too.

SST has been run to the same basic strategy by the same team at FSSA since launch in 1995 but has been revivified in recent years under lead manager Vinay Agarwal, who has cut out lower conviction holdings and concentrated the portfolio in the team’s best ideas. The board and manager agreed on a number of changes in 2020 to improve on previously sluggish performance. This includes taking out structural Gearing for the first time in many years and formalising Martin Lau’s position as co-manager.

As we discuss in the Portfolio section, SST’s portfolio is now much more concentrated and shows attractive financial characteristics, with particularly strong earnings growth expected over the next two years. The team report that their businesses have shown operational resilience through the crisis and have used the crisis to take market share from weaker competitors. The managers say they think the portfolio is better positioned than it has ever been – and we note the team collectively increased their personal shareholdings significantly over the latest financial year.

The discount remains wide at 10.8% (at the time of writing), although this is narrower than the 13% five-year average. The board has been supporting the share price with regular buybacks and has announced a tender offer to be held every five years conditional upon performance versus the MSCI AC Asia ex Japan Small Cap Index (see Discount).

SST’s strong performance in the year to date is promising given its track record of doing well after past global crises. In theory, companies with low levels of debt, good cash generation and strong market positions should be able to steal market share and continue to grow in tough economic environments. The managers tell us this has been evident in a number of holdings in recent months, and, should the recovery from the crisis be protracted, we think this gives reason to be optimistic the market environment has finally shifted back in SST’s favour. In particular, we note that in an environment of high inflation, companies with pricing power should do better – and this is a key characteristic the team look for.

SST is a highly active proposition, with the managers paying little attention to any index. A number of their key characteristics or exposures have worked against them in recent years, contributing to sluggish medium-term performance. However, the managers have stuck to their guns, supported by their board, rather than trying to chase performance. We think there is some evidence their main bias to quality could be a tailwind in the short to medium term. The new tender offer should provide further support to the share price discount over the medium term, and in our view, increase the attractions of the current discount as an entry point.