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Downsizing

13 March 2020

Ian Cowie on why smaller companies make sense for the long term.

Stock market shocks caused by the coronavirus and oil price slump hit headlines in the short term but serious investors should remain focused on the medium to long term. For example, smaller companies may not be household names yet but have an impressive history of generating bigger returns.

Investment companies offer a convenient and cost-effective way to gain exposure to this sector, automatically sharing the cost of professional stock selection and providing diversification over dozens of different underlying holdings to diminish the impact of setbacks or failure at any one company.

Investment companies offer a convenient and cost-effective way to gain exposure to this sector, automatically sharing the cost of professional stock selection and providing diversification over dozens of different underlying holdings to diminish the impact of setbacks or failure at any one company.

That’s important because, although it may be easier for a small business to double in size than it is for a large one to do so, not every acorn grows into an oak. Smaller companies tend to be more likely to rely on a single trade or market than large businesses and less likely to have substantial reserves to enable them to survive unexpected adversity.

However, professional fund managers can benefit from extensive experience, including visiting underlying businesses in which they invest, interviewing their senior staff and scrutinising their books. This can help smaller companies fund managers sort the wheat from the chaff for shareholders, picking plums while shunning sour grapes.

Never mind the theory, how has it worked in practice? After recent shocks to global stock markets caused by the coronavirus and oil price drop, the average conventional investment company - that is, excluding venture capital trusts (VCTs), has lost 9% over the last year, gained 27% over the last five years and 123% over the last decade, according to independent statisticians at Morningstar today, March 13th.

Never mind the theory, how has it worked in practice? After recent shocks to global stock markets caused by the coronavirus and oil price drop, the average conventional investment company - that is, excluding venture capital trusts (VCTs), has lost 9% over the last year, gained 27% over the last five years and 123% over the last decade, according to independent statisticians at Morningstar today, March 13th.

The average UK smaller companies investment company has lost 11%, and gained 33% and 232% over the same respective periods. Interestingly, this sector remains competitively-priced with its average share trading at a 7% discount to net asset value (NAV), compared to the industry average for conventional investment companies of all types trading at a discount of 7%.

Sad to say, I haven’t shared in bigger returns from UK smaller companies investment companies recently. My investment in Rights & Issues (RII) last December has not proved profitable so far, shrinking by 11% over the last year, but it is early days yet. Gresham House Strategic (GHS) is the top performer in the sector with a total return of 13% over the last year. The sector leader over the last five years is Rights & Issues with a total return of 104%.

More happily, I have been a shareholder in Baillie Gifford Shin Nippon (BGS), a Japanese smaller companies investment company, for more than a decade during which time it delivered total returns of 303% with 75% over the last five years. Coronavirus fears crushed returns to a loss of 32% over the last year.

Even so, I remain confident about the medium to long-term outlook and recently added another holding in this sector, buying shares in JPMorgan Japan Smaller Companies (JPS) where hopes of growth in future are supplemented by 5.4% dividend income today. Most smaller companies continue to focus on achieving capital gains but some also pay shareholders to be patient with a decent dividend yield.

For example, I also used to be a shareholder in European Assets (EAT), which focuses on smaller companies on the continent and delivers dividend income of 8.8%. Subject to the approval of each investment trust’s board of independent directors, it is possible to pay enhanced dividends by using some capital growth to supplement income payments to shareholders. However, my most successful smaller company investment companies have placed their priority on medium to long-term growth - and not just Shin Nippon in Japan. For example, JPMorgan US Smaller Companies (JUSC) has delivered total returns of 35% and 234% over the last five years and decade; beating the industry-wide averages over both of those periods.

Whether you seek income or growth or a mixture of both, whether your focus is on the largest economy on earth or exposure elsewhere, it’s well worth considering smaller companies for bigger returns.

For example, I also used to be a shareholder in European Assets (EAT), which focuses on smaller companies on the continent and delivers dividend income of 8.8%. Subject to the approval of each investment trust’s board of independent directors, it is possible to pay enhanced dividends by using some capital growth to supplement income payments to shareholders. However, my most successful smaller company investment companies have placed their priority on medium to long-term growth - and not just Shin Nippon in Japan. For example, JPMorgan US Smaller Companies (JUSC) has delivered total returns of 35% and 234% over the last five years and decade; beating the industry-wide averages over both of those periods.

Whether you seek income or growth or a mixture of both, whether your focus is on the largest economy on earth or exposure elsewhere, it’s well worth considering smaller companies for bigger returns.

For example, I also used to be a shareholder in European Assets (EAT), which focuses on smaller companies on the continent and delivers dividend income of 8.8%. Subject to the approval of each investment trust’s board of independent directors, it is possible to pay enhanced dividends by using some capital growth to supplement income payments to shareholders. However, my most successful smaller company investment companies have placed their priority on medium to long-term growth - and not just Shin Nippon in Japan. For example, JPMorgan US Smaller Companies (JUSC) has delivered total returns of 35% and 234% over the last five years and decade; beating the industry-wide averages over both of those periods.

Whether you seek income or growth or a mixture of both, whether your focus is on the largest economy on earth or exposure elsewhere, it’s well worth considering smaller companies for bigger returns.

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