Capture the return of UK value with Aberforth Smaller Companies

Like a lot of value investments, this investment trust's recent performance hasn't been great and it has underperformed its benchmark, Numis Smaller Companies ex Investment Companies index, over one and three years. As a result, its discount to net asset value (NAV) has widened from under 5 per cent at the end of 2015 to around 14 per cent - one of its widest levels in four years.

This is partly due to UK smaller companies lagging behind larger companies and investor preference for the latter. The trust is also underweight mining companies, which were among the strongest UK equity performers in 2016, "because its managers set a higher hurdle to justify investing in a resource company, because of the inherent corporate governance and political risks faced by the small-cap miners as well as the concentration risk", explains Anthony Stern, analyst at broker Stifel.

But the trust's NAV performance is much stronger than its share price performance over one and three years. So if investors recognise this and value investing makes a comeback, the share price performance could improve and the discount could tighten.

And over five years the trust beats its benchmark and historically its investment team have delivered good returns - since launch in 1990 it has made an annualised NAV return of 13.6 per cent against 11.2 per cent for Numis Smaller Companies ex Investment Companies index.

"Aberforth Smaller Companies has a decent long-term performance record and benefits from being the largest UK small-cap-focused investment trust, contributing to superior liquidity in the secondary market," say analysts at Winterflood. "The trust is differentiated from its peers by its value approach and, while this has been a drag on recent performance, we believe that Aberforth Partners' experience in value investing should add to performance over the long term."

Aberforth Smaller Companies' managers are specialist value investors, and buy companies they calculate are selling below their intrinsic value. They select shares via detailed financial and industrial analysis, combined with a valuation approach that focuses on both stock market and corporate worth.

The trust is well diversified, with 87 holdings across various sectors, which helps to reduce the greater risk associated with smaller companies. FTSE 250 companies and FTSE Small-Cap companies each account for 40 per cent of the trust's assets.

The trust's managers expect a significant number of mergers and acquisitions among smaller companies, which could boost their performance. Its largest holding, e2v technologies (E2V), is being taken over, and Punch Taverns (PUB) has also had takeover offers.

The UK's departure from the European Union could have negative economic effects and smaller companies are more exposed to the domestic economy. Aberforth's managers expect a decline in investment and disposable income, increasing the likelihood of a downturn in 2017.

The trust's board has not been as proactive as it could be in making share buybacks, which could reduce the chances of the discount to NAV tightening. "For example, over the six months to 30 June 2016 the fund bought back 271,000 shares (0.3 per cent of the share capital)," explains Mr Stern. "But they have the permission to buy back 14.99 per cent of shares per annum."

However, company balance sheets are much better positioned than before the financial crisis and valuations have already discounted much of the risk of a domestic recession, argue the trust's managers.

And since 30 June the trust has made further share buybacks, and traded at much tighter discount levels in the past.

So if you want to try to capture the gains of a return to value investing, and benefit from discount tightening on a trust with good long-term performance and which is run by specialist value managers, Aberforth Smaller Companies Trust could be worth a closer look. Buy.

Source: Winterflood as at 25 January 2017, *Aberforth Partners

Performance

Source: Winterflood as at 25 January 2017

Top 10 holdings as at 31 December 2016 (%)

Sector breakdown (%)

IC TIP RATING

Tip style: GROWTH

Risk rating: HIGH

Timescale: LONG TERM