Technology stocks are no longer the biggest sector weighting in Smithson (SSON ) in a ‘watershed’ shift that has seen the global mid-cap equities fund bounce back after last year’s painful growth sell-off.

The £2.3bn investment trust, managed by Simon Barnard of Fundsmith, saw net asset value (NAV) slump nearly a third in 2022. This year, however, it has staged a turnaround with an underlying investment gain of 11.7% as markets re-rate growth stocks in anticipation of a peak in inflation and interest rates.

Half-year results today showed returns outpaced the 1.9% increase in the MSCI World Small and Mid Cap index, although the shares failed to keep pace, rising just 7% as their discount, or gap to NAV, widened to 11%.

It means that since launch in October 2018, when Fundsmith boss Terry Smith was initially in charge of the portfolio, Smithson has generated a 57.5% return on net assets up to 30 June. That’s equivalent to 10.2% a year and is comfortably ahead of the MSCI World Smid index cumulative 37.5% return or 7% annualised.

However, the share price discount means shareholders have actually received a 40% total return and 7.4% annualised which offers a less impressive outperformance of the benchmark.

The disparity in performance is why the board has spent more than £152m buying back 6.4% of the trust’s shares since April last year. While share repurchases haven’t narrowed the discount, the board, chaired by Diana Dyer Bartlett, believes they make the share price less volatile and benefit shareholders by lifting NAV.  

She added: ‘As ever, the most important factor in reducing a discount over the longer term will be a sustained period of good investment performance.’

Tech demoted

Part of the half-year rebound has been a refocusing on sectors that has seen information technology knocked from the top spot for the first time ever. Industrials now make up 33% of the fund, while technology has been bumped into second place at 32%.

Barnard (pictured above in the Citywire studio during a podcast recording last October) said it was a ‘watershed moment in the history of [Smithson]’ and it had ‘occurred for a couple of reasons, some down to our actions, and some not, but none were because of us designing the portfolio to look this way from the top down’.

The increase in industrials came firstly from the sale of US software company Ansys, which reduced the tech weighting, while the addition of IDEX and Exponent increased exposure to industrials.

There was also a change in the definition of ‘information technology’ by MSCI that saw travel technology group Sabre moved to consumer discretionary, while payroll software group Paycom was shifted to industrials.

New addition Exponent is a consulting business that focuses on highly technical areas, including disaster response and litigation. Barnard pointed to the work the group did on the Challenger shuttle exposure, its analysis on the 9/11 World Trade Centre collapse, and the preliminary fire investigation into the Grenfell Tower disaster.

‘It serves a huge array of end markets… [Its] professionals charge anywhere from $190 to $900 an hour and many have PhDs in their respective scientific fields and publish in academic journals,’ he said.

Expo0nent has 20 years of revenue growth in the ‘high-single-digit percentage but operating profit has been compounded at an annual growth rate of over 12%’.

‘We were able to acquire our position at a reasonable valuation, with the shares still trading 30% below their peak in 2021, possibly because it is still only researched by a couple of sell-side analysts,’ said Barnard.

The second purchase Barnard made was Graco, which designs, manufactures and markets systems and equipment to move fluid and powdered materials.

‘It is the market leader in technology for the management of fluids and coatings in both industrial and commercial applications,’ he said.

‘Its products can help customers solve manufacturing problems and increase productivity and quality… We were attracted to the long track record of consistent revenue growth and stable margins, its net cash balance sheet and very strong return on invested capital.’

Simcorp bid

Investment management software group Simcorp was the best performer over the half year after it was bid for by Deutsche Borse that sent the shares soaring 38% in one day.

Barnard said the price offered was ‘not spectacular’ but it is ‘reasonably fair in the current environment, and as there are limited competition and regulatory concerns, we suspect Deutsche Borse will achieve its ambition of a full takeover’.

Cybersecurity solutions provider Fortinet was up 45% over the six months as ‘corporate cyber security budgets remained healthy’, pushing revenues up 32%.

‘This is the fourth time in the past five quarters in which Fortinet has delivered revenue growth of more than 30%,’ said Barnard.

While it was feared that recession would squeeze IT budgets, he explained that the fact that ‘cyberattacks will continue to be a persistent and growing threat – crime goes up during a recession, not down – means cybersecurity spending has had to continue increasing’.

The largest detractor by far was Sabre, which Barnard said is one of the more cyclical businesses he owns, and has been squeezed by recession worries.

‘It is also an outlier in the portfolio, having taken on a lot of debt during the pandemic when travel all but stopped increasing its financial gearing to an economic downturn,’ he said.

‘However, the travel market continues to improve, with the green shoots of business travel recovery now also appearing.’