Could benefit from a small-cap recovery: Global Smaller Companies

GSCT could benefit from a small-cap recovery…by Jean-Baptiste Andrieux

Overview

 
The Global Smaller Companies Trust (GSCT) has been the best-performing constituent in the AIC Global Smaller Companies sector over the past five years, both on a NAV and share price basis, having adapted better to the higher interest rate environment than many of its peers. Manager Nish Patel focusses on businesses with predictable earnings, strong balance sheets, and pricing power, and trading at attractive valuations, with the support of eight regional specialists.

Over the past year, Nish has been adding to companies he considers high-quality and trading at compelling valuations. For example, he has built a new position in SSP, an operator of food and beverage outlets in airports and railway stations. The company has faced a number of challenges during and after COVID, notably increased spending to secure new contracts, but Nish believes these investments will drive future growth. Nish and his team have also identified cyclical opportunities, particularly in real estate-related businesses, which they expect to benefit from falling interest rates. For instance, Nish has added to Jones Lang LaSalle, a real estate services company, anticipating a pick-up in transactions. In addition, Nish and his team have identified opportunities in industries that have experienced underinvestment over the past decade and where returns are improving, such as shale oil. As a result, Nish has increased his holdings in Vitesse Energy, which he views as providing lower-risk exposure to this theme.

At the geographic level, the Portfolio is currently underweight North America relative to GSCT’s composite benchmark, as Nish views valuations as elevated and expects an economic slowdown in the US toward the end of the year. Conversely, other regions are overweight, with Nish and his team finding better-valued opportunities outside the US. The only exception is the UK, as several of GSCT’s holdings have been taken over, leaving the region underweight relative to the benchmark.

Analyst’s View

In our view, GSCT offers comprehensive exposure to smaller companies across both developed and emerging markets, following a prudent approach under Nish’s management, with a focus on quality businesses, valuation discipline, and an avoidance of speculative names. These features have been reinforced since the beginning of the year, as the portfolio’s quality metrics have improved, while its valuation multiple (as measured by the price-to-earnings ratio) has become more attractive, creating, in our view, an even more compelling risk-reward profile. Interestingly, small caps as an asset class are currently trading at valuations more than one standard deviation below their historical average relative to larger companies. When this pattern has occurred in the past, small caps often subsequently outperformed large caps over prolonged periods.

In fact, Nish has identified several catalysts that could kickstart a multi-year cycle of small-cap outperformance relative to large caps. One is an economic slowdown, with Nish expecting the US economy to slow toward the end of the year. Historically, small caps have lagged large caps during slowdowns but outperformed during recessions and recoveries. Lower interest rates could also support smaller companies, as they are generally more sensitive to macroeconomic conditions. Nish also expects inflation to remain higher for longer, which he believes will benefit many smaller companies—particularly many in the industrials sector that dominate niche markets and enjoy pricing power.

Finally, while GSCT is not an income-focussed strategy, the trust boasts a 55-year track record of annual dividend increases. These dividends contribute to total returns and can provide a cushion when share price appreciation stalls, and the trust currently holds sufficient reserves to support further dividend growth.

Bull

• Portfolio’s valuation and quality metrics have strengthened since the beginning of the year
• Potential catalysts could spark a small-cap recovery
• 55 consecutive years of dividend growth

Bear

• Smaller companies have underperformed large caps over the past 15 years
• Valuation-driven investment approach may lag in growthier markets
• Gearing, albeit modest, can exaggerate downside risk

The latest research on Global Smaller Companies Trust here >
 

 

Disclaimer

This is a non-independent marketing communication commissioned by Columbia Threadneedle Investments. The report has not been prepared in accordance with legal requirements designed to promote the independence of investment research and is not subject to any prohibition on the dealing ahead of the dissemination of investment research.