Two UK Small Cap Trust Recommendations

A recent research report from the broker Winterflood has highlighted the value on offer from the UK Smaller Companies sector, which is cheap relative to other markets and its historic valuations. Those who access it via an investment trust may be able to do so below net asset value, as the average discount is currently 10%.

Over the last decade the small cap index has underperformed the FTSE 250 mid-caps and the FTSE 100 blue chips by 12.6% and 17.3% respectively. The returns have also been considerably more volatile with an average annualised risk of 18%.

It is a similar picture internationally, where the UK small caps have lagged behind the equivalent Russell 1000 index in the US by 29.8% over 10 years. However, if you strip out the States they have actually done better than their overseas peers, with a relative gain of 34.4% versus the FTSE Global Small Cap ex US benchmark.

The valuations are compelling, with the FTSE Small Cap ex investment trusts index trading on a 12-month forward PE ratio of 7.6 times earnings, which is well below its 10-year average of 11.9. This represents a discount of around 50% versus its global small cap peers.

Core Recommendation

If you are looking for a core, diversified exposure to UK small caps, Winterflood recommend the £287m JPMorgan UK Smaller Companies trust (LON: JMI). It has been managed by Georgina Brittain for 25 years, with Katen Patel appointed as co-manager nine years ago.

The trust is in the process of absorbing the assets of the firm’s mid-cap fund and once the process is complete it will be renamed JPMorgan UK Small Cap Growth & Income with JUGI as the new ticker. This will have an enhanced dividend policy that will target distributions of four percent of NAV per annum.

Over the last ten years, JMI has significantly outperformed its smaller companies benchmark with a share price total return of 124% versus a gain of 47%. Winterflood describe this as a strong and consistent long-term performance record, with the fund beating the index in 11 of the last 15 calendar years.

They rate the experienced managers highly and say that the merger will increase JMI’s scale, while the introduction of an enhanced dividend policy could potentially act as a catalyst for a re-rating. The shares are currently available at a discount of 10% that broker describes as an attractive entry point.

Complementary Exposure

Investors who want a complimentary holding in the sector might like to consider the £182m Odyssean Investment Trust (LON: OIT).It is different to the other small cap funds as it takes a private equity approach by looking for stocks that are trading below their intrinsic value.

The managers try to unlock the value through strategic and operational initiatives, with the aim of doubling clients’ money every five years across the economic cycle. As you would expect with this type of approach, it has a very concentrated portfolio with just 16 holdings.

Since its inception in May 2018 the trust has generated a NAV total return of 57%, significantly outperforming the five percent increase in the benchmark and 15% return from its peer group. The shares generally trade close to their net asset value.

Winterflood says that Odyssean has performed strongly and offers a differentiated approach to the UK small cap sector. They believe that its rating reflects both the track record and the discount control mechanism, which should limit the downside discount risk should there be any further headwinds.