Henderson Smaller Companies Investment Trust (HSL) reports net asset value (NAV) and share price rose 20 per cent and 28 per cent over the 12 months to 31 May, against a 10 per cent rise for its benchmark Numis Smaller Companies Index (excluding investment companies).
The trust maintained its strong long-term performance record, beating its benchmark and sector average over one, three and five years, both in terms of its NAV and share price returns. The discount to NAV is at a historically tight level of about 7 per cent.
Some of the biggest contributors to performance over the trust's last financial year were housebuilders in which it has been overweight for a few years. Bellway (BWY) made a relative contribution of 1.62 per cent and Taylor Wimpey (TW.) made a contribution of 1.45 per cent. However, Taylor Wimpey has now been sold because when a holding enters the FTSE 100, Henderson Smaller Companies' policy is to sell it within six months.
Neil Hermon, manager of Henderson Smaller Companies, said housebuilders have done well for reasons including a strong housing market, low interest rates and government initiatives. Lack of finance for smaller housebuilders, meanwhile, means less competition and better buying prices. And, more recently, these companies have been capping production rather than looking to expand, enabling dividends and share buybacks, which have resulted in enhanced shareholder returns.
Oil companies were some of the main detractors from performance over the last financial year.
"We are underweight oil and gas, but retain investments in companies we think are strongly financed and can make it through," says Mr Hermon. "This is a challenged space, but we think there is intrinsic value in some companies when energy prices recover."
These include Premier Oil (PMO). "Although Premier has reasonable levels of debt, the company remains financially sound," says Mr Hermon. "It is poised to show good growth in near-term production from the Solan development in the North Sea in late 2015, and beyond that from the Catcher development and the wider North Falklands basin. Premier remains a strong proxy for the eventual recovery in oil prices."
He also initiated a position in Cairn Energy (CNE). "Cairn benefits from a very strong balance sheet with a substantial net cash position," says Mr Hermon. "Current production is minimal, which means low oil prices today are not of huge relevance to Cairn. However, it does have significant developments in the Kraken and Catcher fields in the North Sea, which come on stream from 2017 and will provide substantial production and cash flow."
Mr Hermon has used the recent market volatility as a buying opportunity. This has included topping up Intermediate Capital (ICP), which provides mezzanine finance for leveraged buyouts and manages funds. He has also initiated a new position in RPC (RPC), which produces plastics.
Mr Hermon thinks smaller companies are positioned to do well against large-caps over the medium term and will be driven by mergers and acquisitions (M&A). M&A has picked up recently for reasons including cheap debt and the UK market being open to this kind of activity. In the trust's last financial year, nine holdings were taken over, including Anite, SCR and Domino Printing.
Portfolio companies currently being bid for are Quintain Estates (QED), HellermannTyton (HTY) and Chime Communications (CHW).
Despite its name, Henderson Smaller Companies has over two-thirds of its assets in the FTSE 250 and only a quarter in FTSE Small-Cap shares. Mr Hermon favours the mid-cap area for liquidity reasons, as the trust has £550m in assets under management and he likes to take meaningful positions in companies but not hold too much.
He thinks mid-caps are typically higher quality than smaller companies, and says their superior performance has been driven by earnings growth. Mid-cap valuations are at a slight premium to smaller caps because the former have enjoyed good performance against smallers over the past 10 years. "Mid-caps are trading at their long-term averages so they are not materially expensive, though not cheap either," he adds.
Mr Hermon expects corporate earnings to pick up: "Our portfolio holdings earnings' are still growing at a good level," he says. "Currency impact has become less of a headwind and the UK economy has been strong for some time: this should feed through to better earnings growth in the medium term."
Over its last financial year, the trust increased its dividend by 23 per cent to 13.5p. It currently yields about 2 per cent.
The trust has made some changes to its fee structure: since 1 June the base management fee has been 0.35 per cent of net assets rather than gross assets.
The performance fee continues to be 15 per cent of any outperformance of the benchmark, but the £2m yearly absolute limit has been removed. The trust's board feels this is appropriate as this was set when the trust was half the current size. However, the annual percentage cap on total fees has fallen from 1 per cent to 0.9 per cent of the average value of the net assets during the year.
The trust has a relatively low ongoing charge of 0.88 per cent.
