This ‘standout bargain’ trust investing in small-cap stocks has returned 544pc since 1995

The Montanaro UK Smaller Companies trust offers a double buying opportunity, with shares at a discount to an already cheap market

Questor is reiterating its tip for Montanaro UK Smaller Companies – and flagging a contrarian buying opportunity for UK small-cap funds in general – after a significant investment by its fund management company.

Montanaro Asset Management Limited (MAML), a smaller companies specialist overseeing £3.7bn of investors’ money, last week notified the stock market that it had lifted its stake in the £170m investment trust to 6pc from its previous long-standing level of 5pc.

Cedric Durant des Aulnois, a Montanaro portfolio manager, said this was a “balance sheet investment” by MAML, not driven by end-of-tax-year financial planning. He said it was designed to signal the group’s conviction in the portfolio, which has delivered an impressive 544pc total return since launch in 1995.

However, shareholder gains have dwindled over five and 10 years with the stock down 22pc over three years compared with a 4.9pc decline in the Numis Smaller Companies index. This is caused by an unprecedented investor flight from the UK stock market, coupled with the market moving away from the quality growth stocks Montanaro holds to cheaper, more economically exposed “value” stocks as interest rates rose.

The £1.7m investment lifts MAML’S stake to £10.2m and pushes it to fourth place in the list of long-term shareholders dominated by wealth managers and pension funds.

Their loyalty has been striking given the slump in the share price. At 101.5p, the shares stand just above the 99.2p level at which this column tipped them in August. However, they have tumbled from a peak of 182.5p in September 2021 after the Bank of England ended its near-zero interest rate policy with the fastest series of hikes in three decades in a panic over inflation.

We flagged the trust again in September as a “standout bargain” when the shares slipped 9.5pc below the value of its 35 stocks, alongside other lowly, but attractively priced, small-cap rivals from Aberforth, Invesco, Henderson and Blackrock.

The Montanaro trust gained over 8pc in the fourth quarter of last year as hopes of interest rate cuts buoyed its holdings, such as Marshalls, the landscaping products manufacturer that is its largest position at 5.2pc of the portfolio. This year the shares have drifted with the discount to net asset value widening to nearly 15pc amid uncertainty over when the Bank of England will start to cut base rate after pausing at 5.25pc last August.

Also in the background is the investor exodus from the UK stock market triggered by a combination of Brexit, the dearth of exciting technology stocks and domestic investors’ wish to globalise their savings. Funds investing in UK

‘Its team remains positive on the holdings, which it says are financially strong and trading well’

smaller companies have suffered 33 months of consecutive withdrawals by investors, according to Investment Association data. That doesn’t directly affect Montanaro, which, like all investment companies in London, is a “closed-end” fund. Its fixed pool of capital is unaffected when investors sell the shares. However, open-ended funds have to offload some investments to drum up the cash for exiting investors. That selling pressure has blighted the entire smaller company market and, in combination with “growth” being out of fashion, has led to Montanaro’s underperformance, not because its stock picks are poor.

Its team remains positive on the holdings, which it says are financially strong and trading well. Examples include 4imprint, the promotional products company, which has a “fortress balance sheet” and is grabbing market share; and Greggs, the rapidly growing high street baker that felt confident enough to declare a special, additional dividend to shareholders with its annual results.

“Every valuation metric is telling that you should be buying at this level,” said Des Aulnois who says the market values the portfolio at 10.5 times this year’s forecast earnings, well below the long-term average of 12.4 times.

With UK smaller companies’ valuations not much above their level in the aftermath of the 2008 banking crisis, Questor still believes Montanaro UK Smaller Companies and its rivals offer a double buying opportunity, with shares at a discount to an already cheap market. This could lead to strong returns over the next five years if sticky inflation doesn’t deter the Bank from cutting interest rates.

Questor says: buy

Ticker:

Share price at close: 101.5p