Smithson 11 January 2023

Smithson Investment Trust (LON:SSON) is run by lead manager, Simon Barnard, and assistant portfolio manager, Will Morgan. They aim to offer investors a highly concentrated portfolio, currently comprised of 32 holdings of global small and mid-cap companies. The pair have full responsibility for the portfolio, however, as discussed in Portfolio, the foundations of the investment process are heavily influenced by the longstanding success of the Fundsmith global equity strategy, originated by Terry Smith. The managers hope to identify companies that can generate high returns on capital, with an ability to convert earnings into cash. This leads to a natural bias towards capital-light technology and software companies, but more recently, an increased allocation to highly acquisitive businesses, as the managers believe organic cash flows may become more muted. Given the naturally low yields of the underlying holdings, SSON does not pay a dividend.

As discussed in Performance, the managers’ smaller companies, growth focus and high-conviction approach leads to a more volatile return profile, and this is reflected in the trust’s underperformance over the past 12 months. However, since its inception, SSON has outperformed the peer group and the benchmark in NAV total return-terms.

Since the start of 2022, SSON has traded at a significant Discount, which is currently 7.5%, compared to its historical average premium. However, discount volatility has been high and is reflective of the broader volatility in risk assets. This has resulted in the introduction of buybacks since April 2022, – the first time since the trust’s inception. SSON does not utilise gearing as the managers do not wish to enhance volatility.

Although Smithson Investment Trust (SSON) has had a challenging 12 months, the managers have maintained their quality focused bottom-up approach. The portfolio has been doubly impacted by the macroeconomic challenges facing the market including geopolitical tensions, inflation and rising interest rates through its significant allocation to growth industries, such as technology, healthcare and consumer discretionary, which have sold off indiscriminately, but also through the inherently more volatile nature of the small-cap strategy compared to its large-cap peers.

However, we believe the managers’ high-conviction approach remains a key differentiator, particularly within the smaller companies’ space, where portfolios tend to include a greater number of holdings. Although it does increase company-specific risk and volatility, this concentration should allow the managers to better understand the companies they invest in. In recent months, the managers have shown patience throughout this volatility and have not been fearful of either aggressively trimming positions that no longer fulfil their investment thesis or adding new ones that present a better long-term opportunity.

The structurally changing economic environment may mean that in the short term headwinds will remain for SSON. However, the quality of SSON’s underlying companies in terms of their ability to generate consistent cash flows and potential earnings’ growth may benefit the trust in a rough economic environment. SSON’s current discount of 7.5% may prove an opportune entry point for investors considering the trust has traded on an average premium of 0.7% since inception. However, with the prospects of a recession on the horizon, we would caution that it may take time for sentiment to shift.