It’s official, UK smaller companies trust Odyssean (OIT ) is no longer the cheapest investment company in the UK after a 10% rally following our last report on the closed-end fund this month. 

And annual results this week confirm investors are right to be interested in this concentrated portfolio of special situations and recovery stocks, which the fund managers say performs resiliently in difficult markets.

On 1 June we reported fund manager Stuart Widdowson’s complaint that the area of UK small-cap stocks he follows was trading at its biggest discount to fair value in 20 years. We incorrectly described these as ‘micro-cap’.

According to Widdowson (below), Quest, a cash flow analytical tool first developed by star fund manager Terry Smith, showed small-caps had fallen to a 28% discount to their fair value, in stark contrast to their 37% average premium rating of the previous 20 years.

With Odyssean shares then trailing 9% below their net asset value (NAV), giving them an ultra-cheap ‘Z-score’ of -4.3, investors were presented with a compelling ‘double discount’.

They quickly responded with shares in the £159m trust, which Widdowson manages with Ed Wielechowski, rising from 150.5p to 166p today, putting them slightly above their NAV of 164.4p, thereby removing the discount.

Annual results on Monday underline the attractiveness of Odyssean, which the managers invest in a short list of niche sector leaders and high quality franchises they believe have the pricing power to pass on rising costs to their customers, and protect their margins. 

At the same time they exclude companies engaged in oil and gas production, coal mining, controversial weapons manufacture, pornography and predatory lending 

Strong performance

In the year to 31 March the portfolio of 15 stocks rose 17.7%, smashing the 2.1% fall in the Numis Smaller Companies index (excluding other investment companies but including AIM stocks), and even beating the 13% rise in the UK stock market as measured by the FTSE All-Share.

That outperformance means the fund managers have earned a £2.3m performance fee based on the growth in NAV over the past three years - which the latest data shows is up 61%, the highest in its peer group.

With the performance fee included, that lifts the annual ongoing charge paid by shareholders to a high 1.98%. 

Jane Tufnell, the trust’s chair, defended the payment: ‘The NAV performance is net of the fees and I am content with this as value for money for our excellent team, exclusive as they are to this pool of capital.’ 

She pointed out the managers had to reinvest half of their fee into Odyssean shares and hold these for three years.

The results show it was a busy period for the pair. Premium bids for four portfolio companies Clinigen, Intertrust, Vectura and Spire enabled the managers to plough £91m into new investments, such as electronics company Dialight (DIA), and top-up existing holdings in pension platform provider Curtis Banks (CBP) and Xaar (XAR), the manufacturer of industrial digital inkjet heads. This reduced the trust’s cash cushion from 10.9% to 1.6%.

Xaar was the biggest top contributor to performance, its shares leaping 80% on the back of  strong sales growth.

Opportunities

They also took advantage of share price falls to lift their positions in specialist chemicals and minerals company Elementis (ELM), now Odyssean’s top holding at 14% of assets, and publisher and conference group Euromoney (ERM), which now accounts for 10%.

The biggest detractors to performance were cyber security service provider NCC (NCC) and software company RWS (RWS), which tumbled in the growth sell-off but which the managers continue to back.

‘The significant shifts in market sentiment and style leadership presented opportunities for active management of the portfolio,’ they said. ‘In addition, exit activity was higher than usual, driven by takeovers of portfolio companies. As a result, portfolio turnover was above that which we would normally expect,’ they wrote.

‘In lower growth, and more lowly-rated companies, an ability to deal with inflation will provide opportunity. Where companies are able to pass on price increases quickly and at least recover or over-recover costs, shares should perform well. Uncertainty or temporary de-ratings of these companies provides opportunity.’

The trust’s top 10 holdings represent 83% of its assets, 37% of which is exposed to the industrials sector and 24.2% to tech, media and telecoms. The large industrials exposure reflects the ‘variety of special situations’ in the sector where they believe self-help and ongoing Covid-19 recovery are overlooked by the market.

‘It is notable that almost half of the industrials exposure is in the business to business (B2B) electronics area, where the portfolio had zero exposure at the beginning of the period. In our view the B2B electronics holdings exhibit very distinctive investment cases and are not simply a cyclical play,’ they wrote.