The smaller companies investment trust that is available on a 16% discount

Aberdeen Smaller Companies Income has delivered a benchmark-beating ten year return of over 300%, yet the shares are trading at a much wider discount than its peer group.

It is unusual for a strong performing trust to be in this position, with the most likely reason being the small size of the fund. Aberdeen Smaller Companies Income (LON: ASCI) has a market value of just £79m and limited liquidity, so it is too small to attract large-scale institutional interest, but private investors might be able to turn the situation to their advantage.

When UK smaller companies have done well in the past the discount has normally closed to ten percent and on one occasion it narrowed to around five percent. If you are confident about the prospects for the asset class then it could be a good time to open a position in the fund.

ASCI is unusual as the portfolio has a quality growth focus and an income bias, which sounds like a contradiction in terms. The sort of stocks that it invests in are out-of-favour at the moment with cyclical names in the ascendency, but if UK economic growth slows as predicted in last week’s Budget then they could come back into fashion and the fund be re-rated.

Portfolio

Manager Abby Glennie uses a bottom-up investment approach that focuses on quality, growth and momentum. Where two potential investments have similar characteristics when analysed along these lines they go for the one that pays the higher level of income.

Glennie has a universe of around 800 stocks to choose from and this is whittled down to 40-70 that go into the portfolio construction stage. At the end of September the fund consisted of 52 names including five fixed income securities totalling 1.5% of NAV.

The ten largest positions accounted for a third of the assets with companies like: DiscoverIE Group and Softcat that both operate in the technology sector; industrials such as Morgan Sindall, Strix Group and Ultra Electronics; as well as financial businesses like Liontrust Asset Management and the Intermediate Capital Group. It is heavily weighted in favour of the latter two sectors that together make up around 55% of the portfolio.

Performance

During the first stage of the pandemic the quality growth focus enabled the portfolio to hold up reasonably well, but the development of the vaccines in November 2020 fuelled a strong rotation into cyclicals that left it trailing behind its small cap peer group. Despite this it has still outpaced them over the last three and ten years.

ASCI’s income bias is a secondary factor in the stock selection process, hence the rather uninspiring historic yield of 2.3%, which is well below the weighted average of 3.9% for the UK Equity Income sector. It is really the discount that sets it apart as 16.3% is well out of kilter with the 7.4% average for the UK smaller companies trusts.

Winterflood rate the management team highly and believe that the discount offers relative value, although there is no share buy back policy in place to ensure that the gap will close without any increase in demand. This might happen naturally though, as the fund’s quality growth portfolio would be expected to deliver improved performance once economic growth starts to slow.