Buy into Standard Life UK Smaller Companies' turnaround at a discount

IC TIP RATING

Tip style: GROWTH

Risk rating: HIGH

Timescale: LONG TERM

Performance is even better over one year to the present: NAV total return is 18 per cent against 8 per cent for the benchmark and well ahead of the 12 per cent average return for UK smaller companies investment trusts, putting it among the top three performers.

Its share price returned 8.5 per cent over the year to 30 June and 16 per cent over the last 12 months, meaning it trades at a discount to NAV of 6.4 per cent. But in the past the trust has traded at tighter levels, including at times a premium to NAV, so if its performance continues to improve the discount could tighten.

The fund has recovered strongly after previous periods of underperformance, such as in 2008, and analysts at Winterflood say: "There will be times when the performance of Standard Life UK Smaller Companies will lag its benchmark, particularly when market conditions are volatile. However, we believe that the manager's investment process provides him with the ability to continue to outperform over the longer term. Therefore we would regard any discount weakness as a buying opportunity, particularly given the fund's discount control mechanism."

The trust has a policy of buying back shares at discounts above 10 per cent and implementing tender offers when share buybacks are not sufficient to maintain the discount at an acceptable level.

The trust has increased exposure to high-quality growth businesses with earnings visibility, particularly in healthcare, software and leisure, and reduced exposure to high-growth or more speculative growth businesses. The trust's manager, Harry Nimmo, says its overall risk profile is lower than it was a year ago.

Around 70 per cent of the underlying holdings' profits come from the UK. Mr Nimmo says the UK economy is growing steadily, providing a benign environment for UK small- and medium-sized listed companies. He also says the outlook for corporate profits is still very positive, although companies in more cyclical sectors are showing profit margins at or near cyclical peaks, meaning he has a preference for businesses growing organically.

Valuations for smaller companies remain towards the upper end of the spectrum, leaving the market open to the threat of correction. There is also no guarantee that the trust's performance will turn, or that the discount to NAV will tighten further - it has already tightened from double-digit levels over the last few months.

However, the vast majority of the trust's companies have net cash positions and can grow from internally generated cash flows, while it has a strong long-term track record and has previously recovered from difficult periods.

So, if you have a long-term investment horizon and want exposure to a relatively healthy economy and the potential for smaller companies, with maybe some discount tightening, then Standard Life UK Smaller Companies Trust could be a good bet. Buy.

Source: Morningstar, *Winterflood & **Standard Life Investments

Share price performance

Source: Winterflood, as at 1 September 2015

Top 10 holdings, as at 31 July 2015 (%)

Sector breakdown (%)