... and the trust making sure that it WON’T

ALTHOUGH Henderson

Smaller Companies Investment Trust invests in some of the UK stock market’s lesser known businesses, it constantly strives to mitigate unnecessary risk.

So, it does not invest in unquoted businesses because manager Neil Hermon admits he does not possess the necessary skill set to identify winners from among such early stage companies.

The trust also avoids listed companies – so-called ‘micro’ businesses – that have market capitalisations of below

£100 million, while it will not dabble in any illiquid stocks. A ‘risk’ team separate to Hermon’s investment operation constantly ensures the trust’s holdings are sufficiently liquid.

All these measures were in place long before investment fund Woodford Equity Income imploded in June because of its overemphasis on illiquid holdings – and they will remain a key feature of the way

Hermon and his team go about managing money for the foreseeable future.

Two further factors should reassure investors. First, the trust is broadly invested across some 100 companies, providing shareholders with a comforting level of risk diversification. Secondly, although Hermon will only buy companies that have market capitalisations of below £1.5billion – the ‘bottom’ 10 per cent of the stock market – he will continue to hold them if they enjoy stock market success and grow bigger. It is only if they become part of the FTSE100 Index that he will sell them.

He says: ‘We like to run with our winners, which means some of our most successful stakes have been held for more than ten years.’

A number of the company’s top ten holdings – asset manager Intermediate Capital, housebuilder Bellway and cinema operator Cineworld – are companies with market capitalisations in excess of

£1.5 billion. Over the past five years, the trust, listed on the UK stock market, has performed well. Its share price has increased by nearly 90 per cent, compared with 64 per cent for the average rival trust.

While Hermon acknowledges there are short-term risks aplenty – the unresolved Brexit issue and the possibility of a Corbyn government – he is confident that his financial forensic approach towards picking stocks will help shield shareholders. ‘Yes, Corbyn would not be good for UK equities and the best market news would be a Conservative majority followed by a Brexit deal. But the portfolio we’ve built is constructed for the long term and not dependent on the UK economy.’

An accountant by training, Hermon likes to own companies that possess key traits – the so-called

‘four M’s’. These are good business ‘models’, quality ‘management’, solid ‘money’ numbers (robust balance sheets and strong cash flow) and ‘momentum’ in terms of sustained growth in profit and revenues.

The trust has a low annual management charge of 0.35 per cent although it can apply an additional performance fee if it outperforms the Numis Smaller Companies Index over its financial year. For this extra charge to kick in, the trust’s share price and asset value must have both grown in value.

While Hermon’s emphasis is on identifying growth companies, the businesses he buys tend to end up paying healthy dividends because of strong cash generation. This explains the trust’s ability to pay a reasonable dividend – 23p in the financial year to June, implying an annual dividend of around 2.5 per cent.