Scottish Oriental Smaller Companies Trust (SST) aims to generate capital growth from a portfolio of Asian ex Japan smaller companies which are selected for their long-term growth potential. Manager Vinay Agarwal looks for high quality companies trading on attractive valuations and aims to hold them for three years at a bare minimum, but ideally for much longer.
Vinay took over in 2016 and has revivified the portfolio, accelerating the concentration of holdings initiated by previous manager, Wee-Li Hee, and increasing the focus on a new generation of businesses with strong competitive positions in growing markets. Downside risks are a key consideration. Vinay takes an absolute return mindset to investment, in other words aiming to limit the loss potential even in down markets. The trust is running a cash weighting of 7.7% as Vinay thinks valuations are too high to justify being fully invested, and the trust has been net cash ever since he took over management.
Although performance hasn’t reached the heights of the early 2000s and 2010s, when the trust generated 23% a year for investors (over the ten years to 2013), SST has managed to outperform the MSCI AC Asia (ex Japan) Small Cap Index over the past five years despite the disruption of a number of management changes between 2013 and 2016 and the retirement of two long-standing team members. The Trust also managed to outperform in the falling markets of 2018, testament to the value of the manager’s quality-focused investment thesis.
The objective of the trust is to grow capital, and so dividends are not explicitly targeted. That said, we understand the board is keen to at least maintain the dividend and it has held it at 11.5p for the past six financial years, making use of the revenue reserve to do so. The yield is currently 1.2%.
SST’s discount has been stubbornly wide in recent years, over a period in which - unusually - small caps have underperformed large caps in the region. This discount may also be the result of lingering uncertainty over the management of the trust from 2013 to 2015, as well as underperformance in 2017 when China and more momentum-driven strategies outperformed. The trust is now trading on a 12.6% discount compared to an AIC Asia Pacific ex Japan sector average of 4.8%.
In our view, SST’s portfolio looks more exciting than it has for years, with a “leaner and meaner” line-up of high conviction holdings – now shorn of the lower conviction “tail”. This puts the trust in a stronger position to generate alpha in the future, we think.
While the manager does not take a market view, he is concerned about elevated valuations among the highest-quality companies, which has led him to take a net cash position, but this would not deter us and is in keeping with the team's valuation-conscious approach.
Vinay’s cautious, absolute return approach should help the trust to generate the same impressive protection on the downside as it has in past cycles. By looking through the business cycle to the secular trends in his region, we believe the manager has a good chance of adding significant alpha with the strategy - which has worked for decades on the trust. The discount of 12.6% is too wide, we think, as the market has yet to absorb the changes made by Vinay and respond to what should be a more stable period of management for the trust.
|A consistently-applied process which has proven itself over past cycles||The active approach can lead to underperformance in the short run – for example the trust is heavily exposed to Indian companies|
|A focus on absolute returns and downside protection which should help in rough markets||The yield is low|
|A wide discount, which could close as management is more stable and the trust’s style becomes more in favour|