Invesco Perpetual UK Smaller Companies Trust

Transcription

1 is a clients of Kepler Trust Intelligence. Material produced by Kepler Trust Intelligence is a marketing communication, and is not independent research. Invesco Perpetual UK Smaller Companies Trust Summary Jonathan Brown and Robin West continue to apply the same consistent investment process that has been used for over a decade. They aim to achieve above average returns through the cycle with lower volatility. (IPU) tends to sit in the middle of the pack relative to peers on most portfolio metrics. In terms of market-cap exposure it is neither particularly heavily weighted to mid-caps, nor to micro-caps. The managers look for high-quality businesses with growth characteristics, and a clear preference for companies with balance sheet strength. Since the start of the year, the managers report being slightly frustrated in what they view as a momentum led market, which has better suited competitors such as Standard Life and Old Mutual. However, they observe that as much as offering a strong following wind to the winners, the market has been absolutely brutal to those perceived as losers. Particularly badly hit has been any traditional retail exposure. Jonathan and Robin have been taking advantage of this volatility, by topslicing into strength, and adding to positions where they feel that share prices have been pushed down too far. Over the past five years, the trust has delivered a NAV total return of 15, relative to the benchmark s return of 68, and has beaten the index in four of the past five calendar years. The five-year alpha score is 4 pa, illustrating the manager s strong value add through their lower volatility approach. The dividend, which currently yields 4, is achieved by distributing all the available income arising from the portfolio, boosted by a small proportion from capital profits. The yield therefore compares very favourably relative to other small company funds and trusts, but also those in the equity income sector. And more importantly, the fact that a proportion of the dividend comes from capital means that the managers have not had to tilt their investment approach to achieve this level of income for shareholders. Portfolio Update 19 June 218 Analysts: William Heathcoat Amory +44 () Pascal Dowling +44 () Thomas McMahon, CFA +44 () William Sobczak +44 () Kepler Partners is not authorised to make recommendations to Retail Clients. This report is based on factual information only. This report is provided for general informa-tional purposes only. It is not an invitation or inducement to buy, sell or subscribe to any product described, nor is it a statement as to the suitability or otherwise of any investments for any person. This material does not consti-tute a financial promotion within the meaning of the FCA rules or the financial promotions order. Persons wishing to invest in any of the securities discussed herein should take their own independent advice with regard to the suitability of such investments. Jonathan Brown and Robin West continue to apply the same investment process that has been used for over a decade. The team are benchmark agnostic, and can invest in AIM stocks, although have stated that they will not invest in a company with a market capitalisation of less than 1m. As such, the trust tends to sit in the middle of the pack relative to peers in terms of market-cap exposure neither particularly heavily weighted to mid-caps, nor to micro-caps. The portfolio typically comprises around 8-9 holdings neither very concentrated nor very diversified and no position is allowed to get much bigger than 3 of NAV. This is a pure stockpicking fund. The managers look for stocks with quality and growth characteristics, preferring companies with balance sheet strength. Jonathan 1

2 Fig.1: Market Cap Breakdown of portfolio and Robin aim to find businesses which they perceive as having robust and scalable business models, often in a niche with significant growth potential, which are cash generative and with an ability to re-invest. Ideally, they want to invest in businesses that have the potential to double in size over the next five years, and in typical Invesco Perpetual style, hold them for the long term. Overall, Jonathan and Robin aim to have a portfolio with exposures to a range of sectors (see below) as well as different themes - self-help stories, businesses that can roll out successful concepts or act as consolidators, and what they view as structural growth businesses. The managers focus on higher quality businesses that tend not to boom and bust means that, as we discuss in the performance section, the trust underperforms in sharply rising markets but tends to outperform in more difficult times. Relative to the index the trust is currently heavily underweight financials and basic materials, and overweight technology, industrials and healthcare. The main change from when we last reviewed the trust in Q3 of total assets Source: Invesco Perpetual Fig.2: Asset Allocation Oil & Gas Basic Materials Source: Invesco Perpetual Market Cap breakdown as at 31st March bn bn 5-1bn m Industrials Consumer Goods IPU Asset allocation Health Care Trust Numis SC Index Consumer Services Telecommunications Utilities Financials Technology Cash Benchmark 217 has been to technology, where the managers have been selling into strength and reduced the exposure from 12.5 to 8.8. Having spoken to the managers recently, they report being slightly frustrated by what they view as a momentum led market, which has better suited competitors such as Standard Life and Old Mutual. However, they observe that as much as offering a strong following wind to the winners, the market has been absolutely brutal to those perceived as losers. Particularly badly hit has been any traditional retail exposure. The managers have been taking advantage of this volatility, by top-slicing into particular strength, as well as adding to positions where they feel that share prices have been pushed down too far. Companies that the managers view as having been unfairly punished by the market include Clinigen, 4imprint, Coats, Sanne, and Superdry. Observing that the UK economy is overly reliant on consumer spending and already stretched leverage, they have positioned the portfolio towards resilient companies that they believe are able to generate sustainable profitable growth ahead of the wider economy through market share gains, exposure to higher growth niches and re-investment of cash flows. Top Ten Holdings As At 3 April 218 NAME Safestore 2.5 Johnson Service Group 2.5 Consort Medical 2.5 Dechra Pharmaceuticals 2.4 Equiniti 2.4 Clinigen 2.3 Robert Walters 2.2 Coats 2.4 Faroe Petroleum 2.1 4imprint 1.9 TOTAL 23. Source: Invesco Perpetual We understand that the portfolio (on average) trades at a premium valuation to the wider market, reflecting the higher quality characteristics of the portfolio. The managers expect 8 earnings growth from the portfolio, and currently trades on an average P/E rating of 16x relative to 12.7x for the benchmark. In terms of outlook Jonathan and Robin retain their customary caution given the continued economic and political uncertainty. With overseas sales of the portfolio at c 45, they are seeing company management teams deferring investment decisions owing to Brexit uncertainty. 2

3 They believe that any visibility that the politicians can give will be good for sentiment and business. Gearing The managers have authority to gear the trust to the lesser of 3 of net assets or 25m. However, this is a relatively conservative strategy, and it is therefore not surprising that the managers expect to use gearing only in modest amounts, and even then not often. The managers are also theoretically able to reduce exposure by hedging the portfolio using FTSE 25 futures. Given the illiquidity of this instrument, we understand that they expect to use this very infrequently. Overall, as the graph below shows, based on past history we don t expect gearing to be a driver of returns the trust has nearly always been ungeared, and has historically had lower gearing than the average for the investment trust peer group. Fig.3: Gearing Invesco Perpetual UK Smaller Companies One of the manager s stated aims is to achieve above average performance with below average volatility. As we discuss below, over the long term they have achieved this. However, over shorter time frames, the team often struggle to perform in very strong upward-moving markets and momentum-led periods. Speaking to the managers recently, they report being disappointed with performance year to date, in which they have lagged the average for the peer group. As the graph below shows, this has been mainly a result of the strong run over the past couple of months. The trust remains ahead of the benchmark both over the past 12 months and year to date. A result of the manager s approach, the stocks they pick, and their generally cautious nature, means that IPU has developed a track record of delivering amongst the better risk / reward profiles of the peer group. In the graph below IPU is marked in red, delivering high returns relative to peers, whilst keeping a lid on volatility. Fig.5: 5 Yr Nav Risk And Return (Uk Smaller Companies Peer Group - Ipu Highlighted Red) Gearing (1 = ungeared) IPU Returns Fig.4: Short-Term Performance Invesco Perpetual UK Smaller Companies One year NAV performance 2 The managers aversion to highly geared, lower quality stocks has been a consistent feature of their stockpicking process over the years. This shows in performance terms Fig.6: Discrete Performance 6 Invesco Perp UK Smaller Companies Discrete calendar year returns Jul '17 Oct '17 Jan '18 Apr '18 IPU NAV (Cum Fair NAV) Numis SC Ex IT Morningstar IT UK SMC IA OE UK Sm Cos Source: Morningstar IPU NAV (Cum Fair NAV) Numis SC Ex IT Morningstar IT UK Smaller Co NAV IA OE UK Smaller Cos Source: Morningstar 3

4 that they consistently underperformed the benchmark in 21, 212 and 213, which were characterised by a dash for trash, as previously weak businesses with weak balance sheets were re-rated upwards when it was clear that they weren t going to go bankrupt. More recently, in more stable markets, the team have outperformed the benchmark and achieved a five year alpha score of 4 pa, illustrating the manager s strong value add and outperformance over the benchmark over time. The graph below, which shows relative performance, illustrates the consistency of the manager s performance relative to the benchmark and peers. An upward sloping trajectory shows periods where the NAV is outperforming the respective index or benchmark. A downward sloping line illustrates periods of underperformance. As can be seen, there are relatively few periods of relative underperformance when compared to the benchmark and peers. The recent run of underperformance relative to peers is perceptible, but the net result in terms of outperformance of the index over five years is impressively large. Fig.7: Relative Performance Over Five Years IPU UK Smaller Companies Relative NAV total return performance Dividends are paid quarterly in September, December, March and June. Over the last year, revenue per share increased from 7.37p last year to 8.36p this year. The balance of the dividend is paid from capital reserves, meaning a contribution from capital of 1.8 of net assets (217: 2.1). Paying a dividend from capital is seen in some quarters as possibly controversial, but the board argues that this represents only a small proportion of the current year s returns and the annualised returns over the last ten years. As we illustrate in the discount section, this change continues to have a material impact on appetite for the trust, which has remained on a significantly narrower discount than peers. The board believes that this approach allows them to make a higher proportion of total returns available to shareholders payable through an enhanced dividend, without compromising the integrity of the portfolio or changing the manager s investment. At a yield of 4, IPU therefore offers a highly attractive yield relative to the wider sector, where the average yield for investment trusts is 2.2, and the average for the open-ended sector is.8. We continue to believe that IPU stands apart from peers and other income funds in that the managers investment process (and the quality of the portfolio) is not being compromised for the sake of a higher yield. As such, we continue to believe that for income investors the trust offers valuable diversification from the usual sources. It has the added benefit of being highly reliable (given a proportion is being paid from capital). Fig.8: Annual Dividends IPU vs Numis SC IPU vs Morningstar IT UK SMC IPU vs IA OE UK Sm Cos Source: Morningstar 25 2 Dividends per share (218 - proposed) Dividend pence per share 15 1 A board-led initiative in 215 has seen shareholders dividends increase materially from the level previously, and IPU now has the highest yield in the AIC smaller companies sector. Based on a 2.8p dividend paid for the financial year ended January 218, this translates into a yield of 4 at the current share price. This dividend represents an increase of 21.6 on the previous year s total dividend. Since 215 the board have set the dividend so that it represents 4 of the share price as at the 31 January year end, although they have not formally guided what this dividend might be going forward LLP Peer group Dividend IPU sets itself apart from the investment trust peer group in having a growth bias (similar to the majority of the sector), but aims to achieve above average returns through 4

5 the cycle with a lower volatility. The trust has demonstrated amongst the lowest max. drawdowns over five years (-9.8) and ten years (-38) amongst the closed and open-ended peer groups. In the table below we illustrate the UK smaller companies peer group (having taken out the highly concentrated Marwyn Value and Strategy Equity Capital). Discount As the graph below shows, the board s announcement in March 215 concerning the enhanced dividend had a decisive impact on the discount. Having historically traded at a wider discount than the peer group, it has since consistently traded at a narrower discount. The tender offer opportunity in 217 meant that the trust briefly traded at NAV PERFORMANCE VS PEERS 1 YR RANK 3 YR RANK 5 YR RANK 1 YR RANK Aberforth Smaller Cos BlackRock Smaller Cos BlackRock Throgmorton Dunedin Smaller Cos Henderson Smaller Cos Invesco Perpetual UK Smaller Cos JPMorgan Smaller Cos Montanaro UK Smaller Cos Standard Life UK Smaller Cos Management Having been part of the Invesco Perpetual team in Henley for more than a decade, Jonathan Brown started comanaging the trust in 211. After the retirement of Richard Smith in 214, he was joined by a deputy manager in the form of Robin West, who re-joined Invesco Perpetual after a period as a UK smaller companies manager at Aviva Investors. They are assisted by Luis Mesquita on the smallcap desk and run around 1bn in total. The team have employed the same approach and investment philosophy throughout their tenure. They believe in buying financially strong businesses that can deliver growth independently of the wider economy. They believe in running winners and will continue to own companies even after they have become constituents of the FTSE 1 (although they are not allowed to add to stocks once they reach this index). At Invesco Perpetual, each manager is responsible and accountable for his/her own performance and so, with no house view, stock selection is the sole responsibility of the two managers. Macro views they glean from colleagues are helpful but not a driver of decisions. We understand that Jonathan or Robin will always meet the managers of a company before investing. a premium, and then settled back into the 5-7 range, a considerably narrower discount than the average for peers. There are several features to IPU that the board have designed to try to protect the trust s rating. At the time of the tender in 217, the board has committed to a further range of options being put to shareholders at or around the time of the AGM in 22. In the immediate term, they continue to pay an enhanced level of dividends to shareholders, meaning that the trust yields 4, relative to the weighted average yield for the smaller companies trust sector of 2.4 (Source: JPM Cazenove). The board have Fig.9: Discount IPU discount to NAV UK Smaller Cos Inv Trust sector 5

6 also stated that they will continue to monitor the discount level and may seek to limit volatility through the prudent use of share buy-backs. Charges Jonathan Brown and Robin West continue to apply the investment process that has been used for over a decade. They aim to achieve above average returns through the cycle with lower volatility. (IPU) tends to sit in the middle of the pack relative to peers on most portfolio metrics. In terms of market-cap exposure it is neither particularly heavily weighted to mid-caps, nor to micro-caps. The managers look for high-quality businesses with growth characteristics, and a clear preference for companies with balance sheet strength. Since the start of the year, the managers report being slightly frustrated in what they view as a momentum led market, which has better suited competitors such as Standard Life and Old Mutual. However, they observe that as much as offering a strong following wind to the winners, the market has been absolutely brutal to those perceived as losers. Particularly badly hit has been any traditional retail exposure. Jonathan and Robin have been taking advantage of this volatility, by top-slicing into strength, and adding to positions where they feel that share prices have been pushed down too far. Over the past five years, the trust has delivered a NAV total return of 15, relative to the benchmark s return of 68, and has beaten the index in four of the past five calendar years. The five-year alpha score is 4 pa, illustrating the manager s strong value add through their lower volatility approach. The dividend, which currently yields 4, is achieved by distributing all the available income arising from the portfolio, boosted by a small proportion from capital profits. The yield therefore compares very favourably relative to other small company funds and trusts, but also those in the equity income sector. The fact that a proportion of the dividend comes from capital means that the managers have not had to tilt their investment approach to achieve this level of income for shareholders. 6

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