11:59 Wed 27 Jan 2010
Time to buy unloved investment trust stars Aberforth?
History teaches us the time to buy genuine star managers is often when they are at their most unloved.
Neil Woodford at Invesco Perpetual for example has what he believes to be one of the most undervalued portfolios of stocks he has ever owned, yet his performance has lagged over the past year in a way it has not done for years. The shrewd money is buying him now against the herd.
The same opportunity may currently present itself in the investment trust world through smaller-companies investment trust Aberforth Smaller Companies.
Aberforth has historically been one of the most popular smaller company investment trusts. The management company Aberforth are small-cap specialists who have built up great loyalty among investment trust buyers and institutional investors that has not translated into big sales of open-ended funds. They are publicity shy and also shy away from boasting about their own individual prowess as managers, always focusing on their team approach.
In total there are six partners at Aberforth, four of whom have worked together since 1990. They are always reluctant to name the individuals with the most profound impact on portfolio construction but it is clear the top-down element of the process is led by Richard Newbery and Alistair Whyte. The other responsibilities are divided between Andrew Bamford - who joined the team in 2001, David Ross, David Warnock and Euan MacDonald - who also joined the team in 2001.
Over the long-term the performance record of the trust is impressive. Over five years the trust has delivered an NAV return of 19.94% compared to the -3.98% loss of the FTSE SmallCap (ex investment companies) index. The price performance has been more modest, with a return of 8.85% still smashing the index.
Much of the difference though between the share price and NAV return can be attributed to the trust's unloved status. It is currently trading on a 16% discount. This can partly be attributed to a general nervousness about small-caps in an environment when most UK investors are focusing on more internationally-focused large caps. It is also attributable to the poor period of performance the trust has experienced over the past year.
Over one year it has delivered an NAV return of 51.15% compared to the 68.04% return of the index. The underperformance is in large part due to the team's defensive focus at a time when cyclical stocks have raced ahead.
Like Woodford, they focus on picking companies trading on reasonable - but not necessarily very cheap - valuations with strong growth prospects and unrecognised earnings potential.
Such characteristics have not been fully rewarded in the stockmarket rally of 2009 and the net effect is that Aberforth's current portfolio is significantly cheaper than the index. Brokers Oriel Securities point out the price to earnings ratio on the portfolio at the end of 2009 was just 8.1 times, compared to the 11.2 times offered by the index. Similarly the companies in the portfolio had their dividend covered an average of 3.9 times over, while the index's constituents as a whole are 3.3 times covered.
Oriel's Ian Scouller said: 'Whilst Aberforth had a good year [in 2009] with absolute returns with the NAV total return up 44%, this was well below the benchmark index total return of 61%. The underperformance was the result of stock selection and it is understandable that Aberforth's style of management will underperform at times.
'The discount has widened out to 16%, partly as a result of the performance lag and we think this is an attractive level.
'The shares also have a reasonably good yield of 3.7% and whilst the dividend was 0.92 times covered by earnings, reserves are strong at 1.33 times the total cost of the full year dividend.'
Of course the bear case on this trust is that in markets where momentum and not quality is rewarded there can be persistent underperformance. Yet it is a mark of how respected these managers are that it has not shaken the confidence of key trust opinion formers.
Simon Elliott, a key broker at Winterflood Securities, said: 'Aberforth Smaller Companies has now underperformed its benchmark in four of the last five years. However, we believe that the reasons for this are understandable. In considering market conditions going forward, we believe that there is a reasonable chance that the small cap universe will see rotation into higher quality names that would benefit the fund.
'Furthermore, the fund has traditionally benefited from M&A activity which is predicted to pick-up next year.'
The key advantage of this trust for those willing to take that market view is it is by far the most liquid small-cap trust on the market, with assets of some £511 million.
It has also proven its ability to re-rate significantly when the stars align for the team's management style. While the 16% discount is not unheard of for this trust - it touched more than 20% during its underperformance in the technology bubble - the trust has proved itself able to consistently trade at a premium between 2005-2006 and November 2008-January 2009.
So for those willing to give the managers the benefit of the doubt on their short-term performance there is also an arbitrage opportunity with the discount at these levels.
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