‘Mediocre’ Smithson asks investors to let it invest in bigger targets 

Smithson (SSON ) has proposed changing its strategy to allow larger companies to be added to the portfolio of global small and mid-caps, which has slipped further behind in the race for returns.

The £2.1bn fund is asking shareholder permission to amend its investment policy to allow Fundsmith manager Simon Barnard to invest in any company on the MSCI World Small and Mid Cap index.

Currently, Barnard stock picks companies that have a market value of between £500m and £15bn at the time of initial investment, cutting out a large swathe of the index, where companies are priced between $64m and all the way up to $67.4bn.

The board, chaired by Mike Balfour, said the change will ‘remove an unnecessary restriction’ and ensure the investment universe is ‘made up of the same sized companies as the comparator index’.

While the 20 years to 2020 saw smaller companies outperform their larger counterparts, the trend has reversed since the fund’s launch in 2018. The MSCI World index has returned 120% over the seven year period, while the small and mid-cap index is up just 79%.

Balfour maintained there were still ‘excellent opportunities’ in smaller companies and the focus on mega-caps among other investors means there are ‘many good smaller companies with attractive valuations for an active manager to take advantage of’.

The shift in investment policy may help Barnard revive what he described as ‘mediocre’ performance in 2024 when the fund’s net asset value (NAV) rose just 2.1% against 11.5% growth in the MSCI World Small and Mid Cap index. With a share price increase of 4.9% over the year, this kept the fund trading at an average discount of 11.5%.

The widening of the discount past 10% over the year has triggered a continuation vote. The board has confirmed it will go ahead with the vote in April after an ill-judged decision last year to scrap it, causing much ire from shareholders that forced an eventual U-turn.

Deutsche Numis analyst Gavin Trodd said: ‘The board sticking to its publicly stated policy should not really be newsworthy, although it is after last year’s misjudged decision by the board last year.

‘It is therefore reassuring to see the vote going ahead this year. We believe that the vote is likely to pass, although there was some dissent last year with 10% of votes cast against continuation and another disappointing year for performance.’

Barnard refocuses

These full-year results mark the second time since launch that the fund has underperformed its benchmark, which Barnard said was partly due to the prospect of higher-for-longer rates and spiking gilt yields. Although, he admitted that ‘not everything can be blamed on this’.

He said while there were no major detractors, it was the ‘lack of outstanding winners getting the portfolio motoring’ that hampered returns. The top contributor over the year – US cybersecurity firm Fortinet – would only have ranked fifth in terms of returns in 2023 as shares rose 55%.

The poor run in 2024 prompted Barnard to make ‘incremental changes’ to this process, focusing more closely on areas he believes will deliver the best returns, namely businesses in the lower half of the £500m to £15bn market cap range.

He said there were ‘plenty of future multiple-bagger investments’ available in smaller companies, particualrly in his typical hunting grounds of technology, industrials, consumer and healthcare.

However, that plan seems slightly at odds with the amendment to investment strategy that could allow larger companies into the portfolio.

Last year, Barnard also shed companies that have grown out of the range and added a number of new stocks, boosting turnover to 35.9% from 27.2% in 2023.

The most recent additions have been Monotaro, a maintenance and repair organisation based in Japan, which sells products such as safety clothing and tools.

It also acquired a position in US drug trial outsourcing company Medpace, which is trading on a ‘lower than average rating due to market concerns regarding the post-pandemic funding environment for biotechnology companies’.  

These additions were funded by selling TechnologyOne, which had become the highest rated companies in the portfolio, as well as top performer Fortinet, which had increased its share price four times since Barnard bought it in 2020.

Cognex was also sold due to its ‘exposure to deteriorating economic conditions in China and the global autos sector’.

Barnard said the year’s performance was ‘far from what we expect’. But he maintained that with ‘systematic and disciplined focus on where we hope to find exciting opportunities and an incessant determination to leave no stone unturned in our pursuit of attractive long term investments, we feel confident about the future of the trust’.