The Global Smaller Companies sector is a fairly tight-knit group. Tracked by the Association of Investment Companies, it has a couple of investment trusts with a strong bias to growth and technology, those being Edinburgh Worldwide (EWI ) and Herald (HRI ), the quality-focused Smithson (SSON ), the hard-to-pigeonhole North Atlantic Smaller Companies (NAS ), and BMO Global Smaller Companies (BGSC ).
Over the past 12 months, the star of the show has been NAS. HRI ranks second, despite the recent profit-taking in the tech sector. Its bias to the UK has helped it beat EWI by some margin. Middle of the pack is BGSC. Quality stocks have lagged as more cyclical companies have rallied on the promise of an economic recovery and SSON (which launched in 2018) occupies last place.
One year is perhaps too short a time to judge these funds. Over longer periods HRI and EWI vie for the top spot. At the other end of the scale, the real laggard is BGSC, which has a market capitalisation of £932m. However, I think its manager, BMO’s Peter Ewins, who has been running the fund since 2005, has been fighting with one hand tied behind his back because of its benchmark.
BGSC’s benchmark is an odd construct of 30%Numis UK Smaller Companies index and 70% MSCI All Country World ex UK Small Cap index. From the late 1980s until April 2005, the trust benchmarked returns against what was then the Extended Hoare Govett UK Smaller Companies Index. The rationale for this was that there was no global smaller companies index to measure performance against and the shareholders were predominantly UK investors.
From 2005 to April 2010, the benchmark was split 40:60 between the UK and the rest of the world: 40%Hoare Govett Smaller Companies Index and 60% MSCI World ex UK Small cap Index. The thinking was that the MSCI World Small Cap Index was too dominated by US companies and the board wanted the fund to invest more broadly. By 2010, the directors felt that the benchmark was failing to reflect the growing importance of smaller companies in Asia and emerging markets. Hence the MSCI Index was swapped for the All Countries version and the percentages were adjusted.
Today, my feeling is that investors in London-listed closed-end funds have a wide, perhaps too wide, choice of UK small caps trusts to invest in but a limited choice when it comes to global small caps. The bias to the UK seems anachronistic. A fund benchmarked entirely against the MSCI All Countries World Smaller Companies index – as I would suggest for BGSC – would be a more useful diversifier for UK investors’ portfolios.
At the end of May, my proposed benchmark was about 52% exposed to US small caps, 9% to Japan, 6% to the UK, 3% to Canada and Australia, and 27% in other countries. The index has over 6,000 constituents and, unlike large cap indices, is not dominated by a narrow group of companies or sectors. As such, it’s an ideal benchmark for a stock picker. One that suits a go-anywhere, conviction-driven investor.
BGSC’s recent performance has improved because, since November’s good news on coronavirus vaccines and a Brexit deal was secured, the UK market has had a better run.
Nonetheless, the trust underperformed its benchmark in the year to 30 April according to just-published annual results. The net asset value (NAV) total return was 47.9% versus 54.1% for the benchmark, though the 54% return enjoyed by shareholders was the best in the last 25 years.
The UK exposure was also probably the main driver of BGSC’s underperformance of peers over previous years. Now feels to me like an ideal time to make the switch. A change of benchmark need not result in an immediate change to BGSC’s asset allocation. If Ewins chooses, he can retain the bias to the UK in the hope that it continues to play catch up against other markets.
Pulling up its latest factsheet, BGSC also seems to have underperformed its benchmark over five years, but not by a huge amount (a net asset value total return of 84.2% to the end of May versus 88.7% for the benchmark).
However, investors have suffered from a widening discount over that period, with the trust moving from a modest premium during most of 2016 and 2017 to a 7% discount today. Sorting the benchmark might make for a more straightforward marketing message, which could help that to narrow.
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