A ‘poisonous cocktail of headwinds’ saw JPMorgan UK Smaller Companies’ (JMI)  net asset value (NAV) drop 5% in the 12 months to the end of July, with its fund manager agreeing to a small 10 basis point (0.1%) fee cut as the investment trust’s costs soared.

The £267m trust, which faces a continuation vote on 23 November, performed slightly behind its benchmark, the Numis Smaller Companies plus AIM index, which slipped 4.6% in the period. However, the discount on its share price narrowed from 11% at the end of the 2022 financial year to 10.7%, resulting in shareholders doing slightly better, with a loss of 4.4%.

The discount has widened since to 13%, while its year-to-date performance has been slightly worse than the sector average, with underlying investment returns of 9.2% compared with 9%, according to Numis.

Chair Andrew Impey said the UK smaller company market was hit heavily by Liz Truss’ premiership and ongoing market conditions, including stubbornly high inflation, as he declared a final dividend of 7.7p per share, up from 6.9p the previous year.

The bottom-up stock-picking approach by fund managers Georgina Brittain and Katen Patel made a positive 0.6% contribution to performance, compared with last year’s 6.8% detraction. However, due to the trust’s rising overall costs, including finance costs, which soared to £1.1m from £599,000, the board negotiated a 10 basis point fee cut on its tiered management charge.

The new rate will see JP Morgan paid 0.65% on net assets up to £300m and 0.55% thereafter, down from 0.75% and 0.65% respectively.

The board said it was ‘acutely aware’ of the ongoing charge ratio (OCR) – the total costs expressed as a percentage of company assets – which increased from 0.99% to 1.02% during the period. It said if the reduced management charge had been applied, it would have reduced the OCR by 0.1%.

Portfolio shifts

The managers said the ‘portfolio continued to evolve’ during the financial year as they adapted to the new economic environment.

They added pension consultancy group XPS Pensions (XPS) and car dealership Vertu Motors (VTU) on improved trading and low valuations. The pair also took a small position in Hvivo (HVO), which tests vaccines via human trials, and bar and pub company Mitchells & Butler (MAB).

They sold out of logistic company Wincanton (WIN) and business advisory firm FRP Advisory (FRP) over trading concerns, along with Liontrust Asset Management (LIO), as they did not like its abortive plan to buy Swiss rival GAM.

Gearing, or borrowing, rose during the period to 9.5%, compared with 5.8%, and has risen since to stand at 10% as the managers buy lowly rated shares. The company, which renewed its £50m borrowing facility with Scotiabank for another year, had borrowed £27m.

Impey acknowledged the cost of debt has risen with interest rates but said ‘after reviewing various options, the board believes that the terms agreed remain competitive’.

For their part, the managers said the gearing level ‘reflects our view of the compelling opportunities and valuations currently available’.

Brittain and Patel said the upside from current valuations could be ‘substantial’ as UK smaller companies tend to rally when interest rates are close to peak levels and the merger and acquisition market is already starting to pick up, with their drug developer holding Ergomed (ERGO) receiving a bid after the financial year end.

The pair also highlighted policy shifts by the UK government to encourage investment in the UK equity market, including proposals for some pension providers to invest at least 5% of their funds in unlisted assets, which the managers said should benefit the portfolio as AIM stocks are included in the definition of unlisted.

The long-term track record of the fund is comparatively strong, with NAV total returns of 26% over the past five years compared with 9% for the index.