A rash of UK takeover bids and a cautious approach to lofty US equity valuations has helped BMO Global Smaller Companies (BGSC ) beat its index in the year to 30 April, and declare its 52nd consecutive annual rise in dividends following a strong rebound in investment income.
While fund manager Peter Ewins admitted a 0.2% dip in net asset value (NAV) would not ‘set shareholders’ pulses racing’ after the impressive 50% gain in the previous year, he said it was a resilient performance against the 3.2% decline in its benchmark, which is made up by 30% of the Numis UK Smaller Cos index and 70% the MSCI AC World ex-UK Small Cap index.
After a good first half, stock markets had faded as inflationary pressures rose and the war in Ukraine shattered sentiment and hiked energy costs. Shares in the £768m investment trust, which this week has dropped the BMO from its title and adopted a new ticker of GSCT, fell 6.4% to stand at a discount of nearly 10% below NAV.
Over five years to April, Ewins has overseen a 44.4% total underlying investment return, beating the benchmark’s 42.5%, although shareholders had to settle for just 29.8% because of the discount.
A faster-than-expected 44.4% recovery in dividend receipts was the chief bright spot in a turbulent year. This saw the trust’s revenue returns hit a new high of 1.82p per share, enabling the board to recommend a final dividend of 1.27p and lift the total for the year by 5.1% to 1.84p, extending the line of rising dividends that stretch back to 1970. The trust yields 1.3%.
Outperformance in the US, where Ewins has allocated 43% of assets, the trust’s largest weighting, also protected returns. Stock selection generated 7.8%, despite the 8.3% fall in US smaller companies, as the manager’s reluctance to pay ‘eye-watering’ multiples for companies was rewarded.
Successes included Cerence, the Nasdaq-listed artificial intelligence software developer for cars, where Ewins managed to take profits before its shares tumbled two-thirds this year.
‘Investors have also started to run away from speculative stocks promising profits a long way into the future. Some of these more conceptual business models have started to unravel and, even if they have not, the discounted value of the cash flows they purport to offer long in the future have been devalued by higher rate expectations and a rising cost of capital. We have always been cautious about loss-making stocks and this benefited relative performance,’ he wrote in the annual report.
‘Safe haven’ North America
Ewins told Citywire North America felt more of a ‘safe-haven’ in this year’s geopolitical uncertainty compared to continental Europe, where 10.8% of the trust is invested after a 16% fall in this segment badly underperformed the 6.9% in the regional index.
‘North America has been stronger than Europe for quite a while,’ said Ewins, who invests in both individual stocks and funds.
‘When the war started, there was the initial hit for everything but it has had less of an impact on the US because it does not have the energy crisis that Europe has and it entered the period with more momentum.’
While Ewins said the US economy looked better placed to deal with the fallout from the Ukraine war, he said it is now the region which is seeing the swiftest rise in interest rates, which is having ‘an impact on a broad swathe of companies’.
‘Interest rates have meaningfully moved up and companies are paying more for debt,’ he said.
However, he said the dollar is likely to ‘remain strong’, especially compared to sterling as ‘we have less ability to put rates up in the UK.
Bids boost UK returns
In the UK, where 26.4% of assets are invested, the trust suffered a 3.5% decline, although this was better than the 7.4% slide in the Numis small-cap index.
‘We are still positive on the UK,’ he said. ‘We had a period of a lot of takeovers and we had money coming back from those that we had to deploy.’
A total of 17 of the fund’s holdings have been the target of takeover offers over the year and Ewins lost a number of holdings, including fund administrator Sanne which was taken over by Apex Group in a £1.5bn deal, pharmaceutical services group Clinigen that was bought for £1.3bn by private equity firm Triton, and Brewin Dolphin, which was sold to RBC for £1bn.
The latest of Ewins’ holdings to be approached is Euromoney (ERM). Shares in the business publisher and conference organiser soared nearly a quarter on Monday after it received an offer by a private equity consortium that valued it at £1.6bn.
‘The M&A theme is going strong and you need your fair share of takeovers at the moment [to provide returns],’ said Ewins.
However, Ewins said losing Euromoney would be a blow as there isn’t a ‘ready-made replacement’ for the stock if it agrees to the takeover, unlike wealth manager Brewin Dolphin, which he replaced with Rathbones (RAT) after it received a recommended bid from Royal Bank of Canada.
‘Takeovers are always a double-edged sword because often we quite like some of the stocks and finding a replacement is not always easy,’ he said.
‘We moved into Rathbones but we had preferred Brewin, although Rathbone is similar. Some companies just don’t have an obvious replacement.’
He added that Rathbones had benefited from the ‘good valuation’ Brewin Dolphin received in the takeover.
While Ewins believes there is opportunity in smaller companies, he admitted they ‘are under pressure with a weakening environment’.
‘With rising interest rates, war, and very high inflation, the environment isn’t ideal for any equities but for small caps, there is going to be a slowdown and it is hard to tell how it will move from here,’ he said.
‘The challenge for the rest of the year is inflation,’ he said. ‘We have to be realistic that it will be difficult for corporate earnings, but that is not to say it will not be good for some growth companies. We just need to be careful.’
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