Results analysis: Brown Advisory US Smaller Companies

• Brown Advisory US Smaller Companies (BASC) has released its financial results for the year ending 30/06/2022. The trust saw a -14.0% drop in its net asset value (NAV) on a total return basis and a -23.1% decline in its share price, also on a total return basis. The trust’s benchmark, the Russell 2000, fell by -15.2% over the same period, meaning BASC outperformed by 1.2% on a NAV basis.
• BASC’s returns for the year were achieved in the context of an extremely tough macroeconomic environment for small caps and growth strategies. Rising inflation and interest rate hikes have put downward pressure on equity markets and higher value growth stocks saw steeper price drops as a result. BASC’s relative outperformance was largely the result of the managers’ stock selection, as they avoided areas of the market that had been more susceptible to speculation during the pandemic.
• Gearing was not used in the period under review. Even prior to the drawdowns we started to see in the final quarter of 2021, the managers were cognisant of the fact that US small caps were trading at historical highs and could come under pressure if inflation started to become more pronounced. Cash as a proportion of NAV rose during the period too, as the managers prepared to take advantage of any opportunities during sell-offs in the market.
• During the period under review, BASC’s discount widened substantially from 5.2% to 15.3%. There has not been a dramatic change to this in the intervening period, with the trust’s discount sitting at 16.5% on 27/09/2022. The board aims to ensure the discount is limited to around 10% in normal market conditions. However, market volatility in the reporting period was substantial, meaning share buybacks, which totalled 12,539 shares, were much lower in volume than in the prior year, when 1,025,101 shares were repurchased.
• Despite the difficult macroeconomic environment, the managers have been able to take advantage of lower prices, adding 14 new holdings to the BASC portfolio in the year under review, mainly in the final quarter. Their cash holdings and unused gearing facilities should mean they are able to take advantage of other opportunities if they arise.
• Chairman of the board Stephen White said: “Equity markets are likely to remain unsettled for the time being, and US smaller companies are no exception. However, once the fundamentals do start to improve, we see the US again at the forefront of any recovery. Given their greater exposure to the domestic market US smaller companies should benefit accordingly, thus justifying a dedicated allocation in any portfolio and a commitment to our Portfolio Manager's proven approach in identifying attractive opportunities within the space.”

Kepler View

Brown Advisory US Smaller Companies (BASC) provides investors with access to a portfolio of high-quality US growth companies. Chris Berrier has managed the portfolio since April 2021, but has managed US small cap strategies for Brown Advisory for over 15 years, delivering strong outperformance for investors in that time. His approach for BASC is to look for companies that meet what he terms ‘3G’ characteristics. Those are durable growth, sound governance, and scalable 'go-to-market' strategies, which can take a company from small cap to large cap status.

The past 12 months has been a difficult period for both small cap and growth strategies. Russia’s invasion of Ukraine, rising inflation, and prospective interest rate hikes have all put downward pressure on a market that had reached record highs during the pandemic on the back of huge amounts of government stimulus. Under such conditions, it’s impressive that BASC held up better than its benchmark during the year to June, although it’s worth noting that Chris has historically managed to deliver alpha for shareholders with less volatility and lower drawdown sensitivity than the wider market.

It is impossible to say when the volatility we’ve seen over the past year is going to abate. Nonetheless, looking to the long-term, there are reasons to be more optimistic about BASC’s prospects. On a macro level, the US looks better able to recover from a prospective economic downturn. Energy independent and with a more dynamic economy, it looks less susceptible to the sorts of problems European states are facing today. And like other small cap markets, the companies in which BASC invests tend to derive more of their revenues from the domestic economy, meaning a US recovery is likely to have a meaningful impact on them. Chris’ long-term track record of adding alpha in this market is another reason to be optimistic.

Market volatility has also provided opportunities for Chris to buy, with 14 additions to the portfolio made in the reporting period. These firms all fit within the manager’s ‘3G’ framework, but were available on more attractive valuations. We note that BASC is well-placed to take advantage of further opportunities, given that it has a relatively high level of cash at its disposal and has not used its gearing facilities.

Despite the trust’s long-term potential, its discount has widened since the end of the reporting period to 16.5% as of 27/09/2022. As a result, we believe this makes the shares attractive for those with a long-term view, although we acknowledge the possibility of more volatility in the short-term.

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