Aberforth Smaller Companies Trust (ASL) owns a portfolio of undervalued companies which the managers expect to outperform their more expensive peers. ASL has been team-managed since it was launched in 1990, and has outperformed the Numis Smaller Companies ex IT Index significantly since then.
In more recent years the value style has been out of favour, and ASL has struggled relative to its growth-oriented peer group. As we discuss in the Performance section, the end of last year saw an outstanding quarter of outperformance which was brought to an end by the unforeseeable event of the pandemic.
The resulting market decline now sees ASL on its lowest month-end portfolio valuation since March 2009, which subsequently led to strong returns over the following five years. The managers are investing in their own portfolios and preparing to build up gearing to take advantage of low valuations in the companies most likely to prosper through the other side of the current crisis.
Aside from total-return potential, ASL is also in a strong position with regards to the dividend. Having fallen onto an 11% discount, the historical yield is 3.7%. Although the managers say that they expect to see 50–60% dividend cuts on the market and on their portfolio in 2020, ASL has 2.4 times last year’s dividend in reserve. This means the board has the firepower to maintain or grow the dividend should it wish to.
Following the coronavirus crash, the managers have been through the portfolio with a fine-tooth comb. They have made few changes to their portfolio as a result, remaining confident in most of their business models.
ASL had a stonking fourth quarter last year, and the coronavirus crisis has been a cruel blow for shareholders who were finally being rewarded for their patience after a great bull market for growth over value. However, we think that quarter shows the potential in the portfolio in an improving economic environment.
The managers tell us their base case is for a recovery to start towards the end of the second half of the year, and on their expected course for portfolio company earnings the portfolio’s EV/EBITA will drop into the single figures for 2021 and 2022. Clearly if the crisis does clear and the UK economy can restart vigorously, there is huge outperformance potential in such a cheap portfolio, particularly as it does not include the most troubled areas which large-cap value strategies have been led into (banks and energy).
A lot rests on the course of the pandemic and the policy decisions made to tackle it, as it does for all investment strategies at this point in time. However, investors in ASL have the cushion of cheap portfolio valuations, a discount wider than peers’ (which was close to par in 2019) and very healthy dividend reserves. This means it is entirely in the board’s power to maintain or grow the 2020 dividend – far from a common situation in the market this year.
|Extremely cheap portfolio, at a level which has led to strong five-year returns in the past||Low-rate environment could be unhelpful for value in the medium term|
|Very strong dividend reserves, giving the board flexibility in the dividend crisis||Outlook for the UK and global economy is very uncertain, with potential downside|
|UK-revenue overweight and intention to gear mean the trust could be a geared play on a domestic recovery||Any rise in gearing would increase sensitivity to falling markets as well as rising markets|