Smaller companies are out of favour as nervous investors prefer liquid mega caps (especially those with an AI angle, however tenuous). Nevertheless, in the global smaller companies sector, both Smithson (SSON) and Global Smaller Companies Trust (GSCT) have managed to make positive net asset value (NAV) progress over the past 12 months and are sensible options if you want exposure to this area.

Over that period, SSON has returned 13.6% or 14.1% in share price terms. It is clawing back some of the ground it lost over the first half of 2022, but at £13.82 per share it has a long way to go until it regains the £20-plus highs achieved in December 2021 – before interest rates started to climb.

SSON is a growth-focused fund, like stablemates Herald (HRI) and Edinburgh Worldwide (EWI), but its focus on companies with strong cash flows that can be reinvested to support business growth means that it is better suited to the current environment where equity fundraising is hard and debt finance is more expensive and more difficult to secure.

Nevertheless, 2022 was SSON’s worst year since its launch in 2018. Its holding in Fevertree Drinks (FEVR) proved particularly unhelpful (taking about 3.2% off the NAV), which is ironic as I wrote almost exactly the same thing when I last looked at the trust back in March 2020, although then the hit was 1.5%.

SSON’s ethos is to buy good companies at reasonable valuations and then stick by them. This has similarities with Nick Train, although SSON has a few more holdings than Finsbury Growth and Income (FGT) at 33 to 22.

Where it perhaps went wrong in the past is not selling companies that were no longer at reasonable valuations. The manager admitted as much in its last annual report. However, its emphasis on quality, defensible business models and cash generation ought to stand it in good stead if the current slowdown becomes a global recession.

GSCT fared much better than SSON in 2022’s growth selloff and therefore has much better three-year performance figures (up 29.4% over the period versus 8.8% for SSON).

In contrast to SSON, GSCT has a much more diversified portfolio of both direct holdings and positions in funds, including stakes in Scottish Oriental Smaller Companies (SST) and Utilico Emerging Markets (UEM). The funds are used to get exposure to areas where the manager does not have in-house expertise. The direct equity portfolio is split into a number of smaller regional portfolios and Peter Ewins, the lead fund manager, asset allocates between these.

US small caps are much more expensive than their developed world counterparts. This is the principal reason why GSCT is underweight North America relative to its benchmark. With the dollar weakening, that has been a good decision.

By contrast, UK stocks look cheap. SSON has a tactical overweight exposure to the UK relative to its MSCI World SMID Index benchmark (16.6% to the index’s 5.3%). GSCT is also overweight the UK but in its case this is strategic.

Back in 2021, the UK was 30% of its benchmark. On 1 May 2023, the board decided to reduce it to 20% Numis UK Smaller Companies (ex investment companies) and 80% MSCI All Country World (ex UK) Small Cap. A natural weighting for the UK would be 6% (its proportion of the MSCI All Country World Small Cap index), but given the vast selection of UK smaller companies trusts to pair it with, my inclination would be for it to have a zero weighting to the UK.

Had it much reduced or even eliminated its UK exposure, GSCT’s recent performance would have been a bit better. The UK part of the portfolio was the worst-performing in the year to the end of March 2023 as stock selection here was a drag on returns.

The best part of the portfolio was in Japan – one of the areas where it subcontracts the job to external managers. Eastspring Investments, the managers of GSCT’s largest fund position at 4.4% at the end of April, follows a value approach, which brings it closer to the small cap corporate governance funds and CC Japan Income & Growth (CCJI) in terms of style rather than say a Baillie Gifford Shin Nippon (BGS). That seems to be working well at the moment.

Discounts are widening across the investment companies sector and these two funds are no exception. GSCT used to have a discount problem but managed to fix that in the mid 2000s and traded at a premium for many years in the 2010s. However, at 17.2% its discount is now approaching its widest level for a decade. It is buying back stock on a daily basis.

SSON’s shares are trading on an 11.6% discount currently, which is about as wide as the discount has ever been. It has been buying back stock but could perhaps be a bit more aggressive about this. The value of its buybacks in 2022 and 2023 to date are far below the level of inflows that the company saw in earlier years.

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