Henderson Smaller Companies Investment Trust: September 2021 update

• Neil Hermon is an industry veteran with over three decades of investment experience
• His bottom up approach centres around quality growth at a reasonable valuation
• Long-term performance has been strong since Hermon took over the trust in 2002

How it fits in a portfolio

Henderson Smaller Companies Investment Trust aims for long-term growth by investing in higher-risk small and medium-sized UK companies. Companies of this size have more room to grow than larger, more established ones but they tend to be more volatile. More than half the trust is invested in FTSE 250 (Mid Cap) companies so it could work well alongside other investments in small or large companies as part of a wider UK or global allocation. The manager’s growth style could also complement other investments focused on unloved ‘value’ companies.

When investing in closed-ended funds you should be aware the trust can trade at a discount or premium to net asset value (NAV).

Manager

Neil Hermon, Director of UK Equities, has managed this trust since joining Henderson (now Janus Henderson) in 2002. With over 30 years in the industry, he has plenty of experience when it comes to finding smaller companies with potential. His career began with Ernst & Young as a chartered accountant before moving to General Accident Investment Management (later to become CGU), where he was head of UK smaller companies.

Alongside this trust, Hermon also manages the Janus Henderson UK Smaller Companies Fund, an open-ended fund which uses a similar investment process to this trust. He also co-manages the Janus Henderson UK Alpha fund alongside Indriatti van Hien, which mainly invests in medium-sized and larger companies. Given the overlap in approach and company size, we believe Hermon can devote enough time to each.

Process

Hermon’s investment process has remained the same since he started manging the trust. His investment style is known as ‘GARP’ - growth at a reasonable price. This means he doesn’t want to overpay for a company’s shares based on its growth potential. He invests for the long term with an average holding period of around five years.

Detailed company analysis is key to selecting investments and Hermon uses what he calls the ‘4Ms’ to judge the quality of a company:

• Model – the business model, advantages over competitors and pricing power
• Management – the strategy, vision and governance of the management team
• Money – the company’s financial strength
• Momentum – the ability of a company to keep growing its earnings in the future

This filters the universe down from over 1,000 companies to a final portfolio of around 100. He likes to invest when companies are small and remain invested as they mature – ‘running his winners’. This is why over 50% of the trust is invested in mid-caps. That said, once a company is big enough to enter the FTSE 100 it is automatically sold within six months.

Compared to its benchmark, the trust invests more in sectors such as software and computer services, electronic, household and leisure goods. It invests less in areas like travel and leisure, banks and real estate investment trusts (REITS). Geographically, the trust has a fairly even split between companies that generate revenues in the UK and overseas.

Over the past year Hermon has found numerous opportunities for the trust. These include Auction Technology Group. He believes the outlook is strong for the online auction marketplace as Covid-19 accelerates the digital shift from a traditionally physical venue. Other new additions include online card retailer Moonpig and The Restaurant Group, owner of brands like Wagamama and Chiquito.

There have also been some departures. Several of those were through takeover bids being accepted such as gaming company Codemasters from Electronic Arts and medical device company Vectura from private equity group, Carlyle. Others such as cinema operator Cineworld were sold through choice. The pandemic has left the company with higher levels of debt and an uncertain future ahead. Other sales included storage company Safestore and foam manufacturer Zotefoams as Hermon believed their share prices reached a point that presented an attractive exit point.

The managers use gearing (borrowing to invest), which can boost gains but also increases losses, so it’s a higher-risk approach. They can invest in derivatives too which, if used, also adds risk.

Culture

The trust was founded in 1887 and is a constituent of the FTSE 250 index. It’s managed by Janus Henderson Investors, a large investment firm with offices all over the world, formed in 2017 from the merger of two long-established groups – US-based Janus Capital Group and Henderson Global Investors.

It values experience, and so fund managers at the group have on average over two decades of investment experience. Sharing knowledge and ideas between investment teams is an important part of the culture. Managers have the flexibility to tap into the wider group’s resources for ideas and insights, but also have the freedom to do their own research and form their own views without having a ‘house view’ placed on them.

Cost

The trust's ongoing charge was 0.98% for the 12 months to the end of May 2021. This includes a performance fee which was applied for their outperformance during the trust’s financial year. We’d prefer it if there wasn’t a performance fee as it can hold back investors’ returns. If held in a SIPP or ISA the HL platform fee of 0.45% per annum (capped at £200 per annum for a SIPP and £45 for an ISA) also applies. Our platform fee doesn’t apply if held in a Fund and Share Account.

Investors should refer to the latest annual reports and accounts and Key Information Document for details of the risks and charging structure.

Performance

The trust’s performance has been strong over the long term. Since Hermon became manager in November 2002, the trust’s share price has risen by 2276.2%* vs 1171.3% for the AIC sector average. We believe this is a result of Hermon’s stock picking ability which has helped the trust outperform in 16 of his 18 years in charge. Past performance is not a guide to the future though and exceptional returns are unlikely to be consistently repeated. Investments fall as well as rise in value and you could get back less than you invest.

During the 12 months to 31 May 2021, the trust’s latest financial year, the net asset value (NAV) grew by 58.5%, compared to the sector average NAV increase of 49.4%. The share price also increased by 69.3% over the same period which was helped by a narrowing discount.

The trust’s dividend for the past financial year also increased by 1.1% to 23.75p. However, this was in part funded through revenue reserves built up over previous years and dividends are variable and not guaranteed.

Impax Asset Management was one of the top performers during the trust’s financial year. As an environmental social governance (ESG) specialist, the company’s assets have seen strong growth as investors turn their attention towards more sustainable solutions. Media company Future was another strong performer as Covid-19 increased its clients spending budgets on digital marketing.

In contrast, Covid-19 was behind the trust’s largest detractor, Clinigen, the pharmaceutical company. With healthcare efforts being focused elsewhere, demand for its existing drugs declined and the approval process for new drugs was delayed.

Heightened M&A (merger and acquisition) activity also had an impact on returns, both positively and negatively. For example, Electronic Art’s takeover bid for Codemasters was at an attractive premium to its share price. In contrast, not owning betting company William Hill, which was bought by Caesars Entertainment, a US entertainment firm, hindered performance.

Past performance isn't a guide to the future. Source: *Lipper IM to 31/08/2021.

Find out more about Henderson Smaller Companies Investment Trust including charges

View Henderson Smaller Companies Investment Trust Key Information Document