Buy growth at a discount with Scottish Oriental Smallers

Scottish Oriental Smaller Companies Trust (SST) could present such an opportunity. The trust has been through a number of management changes over the past few years following the retirement of Susie Rippingall in 2012, who led it through years of superb performance. But this now seems to have settled down: lead manager Vinay Agarwal of First State Stewart Asia has been in charge for over 18 months, supported by Wee Li Hee. Mr Agarwal also runs the top-performing First State Indian Subcontinent Fund (IE00B6Y13T06).

The trust's current managers continue to follow First State Asia's philosophy of investing for growth, but with a key focus on minimising losses.However, Mr Agarwal has made changes to the trust's holdings since taking charge, and takes bigger bets on fewer stocks.

The trust has over a quarter of its assets in India, a growing economy. This is far higher than MSCI AC Asia ex Japan index's weighting to India and Asia Pacific ex Japan investment trusts' average level of India exposure. The Philippines, meanwhile, accounts for 10 per cent of the trust's assets despite being barely represented in this index.

But Scottish Oriental Smaller Companies' 10 per cent allocation to China is significantly lower than MSCI AC Asia ex Japan index's and its sector peers' average weightings to it. This is because Mr Agarwal thinks that cheap debt has fuelled a misallocation of capital in businesses, particularly in China and Korea. He says companies in India, Indonesia, the Philippines and Sri Lanka are less leveraged so likely to do better over the long term.

Wealth manager Killik believes the trust is now more concentrated on faster-growing companies with the potential to deliver multi-year growth and emerge as winners in their respective industries, and this could lead to a narrowing of its discount to NAV.

"[Scottish Oriental Smaller Companies'] share price discount has widened in recent months and currently trades on the wider end of the medium-term range so looks like an attractive entry point for long-term investors," say analysts at Killik.

The trust's discount has widened since Mr Agarwal took charge and is currently at about 14 per cent –  wider than its 12-month average of 11 per cent. The trust's small-cap remit and its managers' preferences mean it has not been overly exposed to China or technology stocks, two markets that have done extremely well in recent months. As a result, the trust has underperformed the MSCI AC Asia ex Japan and MSCI AC Asia ex Japan Small Cap indices, and the Association of Investment Companies (AIC) Asia Pacific ex Japan sector average.

Despite the trust's positioning away from potential problem areas and its risk-conscious approach, it has exposure to smaller companies and emerging market equities, so still carries significant risk. Market volatility has been a feature so far this year and losses have been greater in Asian smaller companies. And Mr Agarwal is currently hesitant to invest, which could be a short-term drag on performance and the discount narrowing. The fund has a 6.4 per cent cash allocation because he thinks many stocks are overvalued – something only a market correction could solve.

However, analysts believe that Scottish Oriental Smaller Companies' discount is not justified because its management overhaul seems to be complete and its returns could improve in the near future. And although its managers' risk-conscious approach means that when markets rise sharply their funds are left behind, this disciplined strategy means they often come out on top over the long term. First State Asia fund managers follow strict rules on stock valuations, only buying companies based on their own merits and holding them for the long term.

So if you have a long-term investment horizon and high risk appetite, Scottish Oriental Smaller Companies looks like a good way to access growing companies in developed and emerging Asian markets. And as it trades at a discount wider than its historic average, this could be a good moment to enter a trust run according to a strategy that has been proved over the long term. Buy. TL

Scottish Oriental Smaller Companies Trust (SST)

Source: AIC, *First State Stewart **Winterflood

Performance

Source: FE Analytics, as at 20.04.2018

Top 10 holdings as at 31 March 2018 (%)

Source: First State Stewart, as at 31.03.2018

Geographic breakdown (%)

Source: First State Stewart, as at 31.03.2018