This week I want to ponder the importance of investment style on returns. It is over three and a half years now since interest rates started to climb and investors fled a swathe of trusts, triggering the discount issues that have plagued the sector since. However, it is also now a year since the Bank of England began cutting rates. 

Even though there is a sense that the next rate cut is a way off, with the latest reduction to 4% (1.25% below the recent peak) in the bag, it feels reasonable to wonder why investor sentiment towards many of the trusts that were hit in that selloff is still lukewarm at best.

Falling interest rates are not just a UK phenomenon. US rates started to drop last September, and while there has been disappointment – not least in the White House – that this has stalled so far in 2025, the general consensus is that the trend is still downwards. In Europe, rates are less than half the level that they were in May 2024. Interest rates are falling in China and India too. Only in Japan are they going the other way.

Looking at the returns on the MSCI All Countries World style indices, growth and momentum are still doing much better than value over the past year. Large caps are outperforming mid caps, and small caps trail behind by some distance. In addition, as has been the case for some time, investors do not seem to be looking for ‘quality’ stocks.

The numbers seem to reinforce the idea that the only theme that is working currently is mega cap AI. You would definitely get that impression by looking at how far Manchester & London (MNL ) portfolio returns are ahead of its global peer group.

MNL has big bets on Nvidia and Microsoft, which account for about two thirds of its portfolio. Their success means that its 10-year numbers have even overtaken those of Scottish Mortgage (SMT ). Those two stocks are also the two largest positions within the large-cap technology trusts – Polar Capital Technology (PCT ) and Allianz Technology (ATT ) – which are also enthusiastic supporters of the AI theme.

Discounts of 9-10% for the two tech trusts and 14% for MNL might imply that trust buyers are nervous about how long this amazing run of performance will last. However, the managers remain convinced that the AI story has a long way to run yet. Although, as PCT’s managers have been highlighting, there will be losers as well as winners, and some of those losers may yet include some of the mega-cap tech stocks that investors have been pouring money into.

Considering ‘contrarian’ Smithson

A contrarian might look to the factors that are most out of favour – small cap and quality – and look for opportunities there. Here, an obvious candidate might be the largest of the global small-cap trusts, Smithson (SSON ), which despite an aggressive share buyback programme (over 35% of its shares repurchased so far) still has a market cap of about £1.7bn.

SSON’s recently released interim results tried to sound an upbeat note. However, based on data at close of play on 6 August, at 6.3%, SSON’s one-year NAV return is the second worst in the global small cap sector. Only North Atlantic Smaller Companies (NAS ) has fared worse with a return of 5.2%. Unfortunately, it also lags the 13.6% return on its MSCI World SMID Index benchmark over 12 months.

SSON’s end July 2025 factsheet shows that it has just failed to match its benchmark since launch in October 2018. That masks a period of very strong performance in 2020 and disappointing relative returns in 2022 and 2024.

SSON operates with a high conviction (just 33 stocks at end July), buy and hold portfolio of growing, cash generative companies, generating high returns on capital, and with strong balance sheets. When interest rates were abnormally low in 2020, that approach was highly prized. That situation reversed in 2022, and selling pressure meant that the trust, which had tended to trade at a premium, shifted to a discount.

The persistence of that discount has triggered continuation votes, which SSON famously tried to dodge in 2024. But perhaps because dissatisfied investors have tended to sell into the buyback, it has survived these comfortably, with only 3.8% of votes cast against continuation this April.

While investing with a quality style carries risks if the manager’s perception of quality turns out to be flawed – stocks can derate quite savagely if they disappoint – my impression is that SSON has not had more than its fair share of poorly performing stocks.

In addition, the portfolio’s regional biases – underweight the US and overweight UK and Europe – have been working in its favour over the past 12 months.

My sense is that the trust’s problems are almost entirely down to its investment style. It is possible that a slowing US economy might encourage investors to look on quality stocks more favourably, but there is no guarantee of that. I am not yet ready to make this contrarian bet.

James Carthew is head of investment company research at QuotedData.

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