Star Henderson Smaller Companies manager Neil Hermon has reduced exposure to companies exposed to slowing housing market. However, a topsy-turvy year did not dent the trust's long-term winning streak.
In the year to June Hermon disposed of six positions in the £589 million portfolio. These included Carpetright (CPR), which provides carpets, flooring and beds, after increased competition and a weak housing market caused its share price to come under pressure.
Hermon, who has a Citywire AA-rating for the three-year returns on two open-ended funds, including HSL’s sister fund Henderson UK Smaller Companies, also sold out of LSL Property Services (LSL) according to full-year results published yesterday.
LSL provides services to buyers and sellers of residential properties, tenants and landlords. Hermon highlighted tough trading conditions caused by falling housing transactions and pointed to growing competition from new online entrants.
Hermon, who has run HSL since November 2002, is also concerned that the UK consumer faces a host of pressures. Here, the small company investor is referring to the growing costs of imported goods as a result of the weaker pound, political uncertainty created by the recent hung parliament election result and ongoing Brexit negotiations.
The star fund manager suspects these dynamics will result in the consumer becoming more cautious, which helps to explain why he also sold out of second-hand car dealer Motorpoint (MOTR) over the year to June.
In the 12 months to 30 June, the investment trust grew its net asset value (NAV) by 28.7%, while share price delivered a total return including dividends of 32.7%. Both beat the 23.9% from its benchmark, the Numis Smaller Companies Index (excluding investment companies).
It was a challenging year for many investors who were not expecting to see the UK vote in favour of leaving the European Union or for Donald Trump to be elected US president.
‘I said last year that uncertainty would remain until investors felt confident that the way forward for the UK was resolved. Given these conditions it seems unlikely that interest rates will rise significantly anytime soon and therefore sterling is likely to remain weak,’ said the trust’s chairman Jamie Cayzer-Colvin.
Considering the headwinds facing the UK, the chairman explained: ‘This is the time to stick to what we do best, and we remain confident that skilled active investing founded on the basic fundamentals of investing in quality growth at the right price will win through in these uncertain times.’
Melrose Industries (MRO) was a top performer for Hermon, with a 230.8% return during the year. The company buys underperforming manufacturing businesses and then aims to turn them around.
‘The management team are highly rated due to their demonstrable track record of making money for shareholders,’ said Hermon.
Nortek, a US-based provider of building products acquired by Melrose in late 2016, is already showing signs of improving margins and return on capital employed.
‘With plans to make further enhancing acquisitions, we continue to be firm supporters of the Melrose story,’ the manager added.
Renishaw (RSW) was another strong contributor, with a 92.5% total return over 2016/17. It manufactures high technology precision measuring and recently invested in the smartphone production chain. As an exporter, the company benefited from the weak pound.
‘Renishaw, with a very strong balance sheet and a well-invested production base, is superbly positioned for the long term,’ Hermon added.
It wasn’t all plain sailing over the 12-month period, however. Essentra (ESNT), which specialises in cigarette filter production and healthcare packaging, had a difficult year after poor integration of acquisitions in its packaging division led to delayed and cancelled orders. This hit profitability.
Although the share price has rallied after a new management team was appointed, Hermon sold the position towards year-end as he believes the share price had already discounted a significant recovery in profits.
Smaller companies sold off after the Brexit vote last summer, as investors feared that domestically-focused companies, which are reliant on the strength of the economy, would come under pressure. This hurt smaller companies trusts, whose shares fell further behind their portfolios. HSL’s discount to net asset value widened to 18% late last year but has since narrowed back a bit to 14.6%.
The board said it will continue to monitor the discount and is considering the merits of buying back shares. Nevertheless, right now it does not believe that share buybacks represent the most effective way of generating long-term shareholder value.
Over ten years to 10 August HSL ranks fourth out 20 investment trusts in the Association of Investment Companies’ UK Smaller Companies sector with a total return of 224.5% compared to the 197.7% average gain. It also beats the Numis Smaller Companies (ex-investment companies) index return of 143.6%.
Its five-year return of 185.6% is second best in the sector - behind Rights & Issues (RIII) on 277% - but again beats the sector average of 156% and the Numis index gain of 104%.
In the near 15 years that Hermon has run both the smaller companies investment trust and its open-ended investment company (Oeic) equivalent, the former has trounced the latter. The investment trust's ability to use gearing (borrowing) to up its firepower and avoid having to sell stocks in a downturn have had a powerful long-term effect, according to fund performance data from Lipper.
Between 31 October 2002 and 31 July 2017 Hermon generated a total return of 1,155% for shareholders of Henderson Smaller Companies. By contrast, his Henderson UK Smaller Companies Oeic returned just 698%, although this was well ahead of Numis Smaller Companies on 599% and also beat its average open-ended rival which lagged the index with a 568% total return.