• One of the UK’s top performing fund managers, Keith Ashworth-Lord, is launching the Buffettology Smaller Companies Investment Trust
• Offer period of £1 per share closes Friday 23 October
• Is it foolish to invest in British smaller companies right now?
• The Buffettology approach - £1,000 into £3,490 since launch in March 2011
• Buffettology v Buffet – who wins?
• Other smaller company fund picks
Laith Khalaf, financial analyst at investment platform AJ Bell:
“It’s a brave time to be launching a smaller companies trust, in the face of a bleak economic picture and the considerable antipathy towards the UK stock market. However negative sentiment throws up opportunities for active managers and Sanford DeLand’s focus on quality businesses should offer some downside protection for investors in the Buffettology Smaller Companies Trust.
“The success of this float will be a good litmus test of investor appetite for the UK. Just a few weeks ago, Tellworth pulled the launch of their British Recovery and Growth trust because of weak interest. Sanford DeLand do have the kudos of the Buffett name on their side, as well as the outstanding performance of their existing funds.
“Smaller companies is an exciting area of investment that can deliver outstanding long term returns, albeit with higher levels of volatility. It’s also an area where active managers can add a great deal of value, seeing as they’re fishing in a part of the market which isn’t heavily analysed.
“The UK economy isn’t in great shape right now and that will act as a drag on the performance of business of all sizes. However one of the great things about smaller companies is they have the ability to shrug off the macro-economic environment and deliver idiosyncratic earnings growth. Small cap investors should be long term in their outlook and need to have the mettle to ride out the downdrafts, which can be pretty breath-taking.
“Sanford DeLand’s Buffettology approach targets quality companies with robust finances and wide economic moats. This is particularly appealing in the smaller companies market where resilience is at a premium.
“However the average UK Smaller Companies investment trust is currently trading at a discount of over 9%, which itself is a large moat for the Buffettology brand to bridge. If demand fails to live up to expectations, investors might find they are able to buy in below NAV once the trust is trading on the market. Investors who buy in during the offer period also have to stump up the set up costs of the trust, estimated to be 2p in the pound.
“For those who like the cut of the Buffettology jib and would like to temper their smaller company exposure with some bigger companies, Sanford DeLand’s existing UK Buffettology and Free Spirit funds have a significant stake in the minnows of the stockmarket.”
Why invest in UK smaller companies?
Simply put, smaller companies have the potential to deliver higher returns over the long term than their large cap cousins. They have greater scope to both grow their earnings and to become more widely recognised by equity analysts and professional investors which serves to boost share prices. The cost of the higher expected return in the long run is higher levels of volatility and potential loss.
As the table below shows, the FTSE Small Cap Index has trounced the return of the FTSE 100 over 5, 10 and 20 years. So has the FTSE 250, indeed over 20 years the mid cap index has blasted the return from small caps too. Mid caps enjoy a bit of a sweet spot between large and small companies where they are established enough to weather tough economic conditions and still nimble enough to grow quickly.
|
Total Return / % |
|||
|
5 years |
10 years |
20 years |
|
|
FTSE 100 |
15.3 |
55.4 |
101.5 |
|
FTSE 250 |
21.4 |
119.9 |
388.3 |
|
FTSE Small Cap |
31.3 |
127.0 |
173.4 |
|
IA UK Smaller Companies |
41.4 |
166.6 |
319.8 |
|
AIC UK Smaller Companies |
29.9 |
177.5 |
318.6 |
Source FE, Total Return to 12 Oct 2020
The table also shows the benefit of active management in the smaller companies space, with the performance of the average UK open ended smaller companies fund (IA UK Smaller Companies) and the performance of the average closed ended smaller companies trust (AIC UK Smaller Companies) both significantly outperforming the FTSE Small Cap Index over the long term.
Of the 44 funds in the Investment Association UK Smaller Companies sector with a 10 year track record, 37 have outperformed the FTSE Small Cap Index over this period. Top quartile funds have returned on average £3,870 per £1,000 invested (source FE, Total Return to 12 Oct 2020). There is some survivorship bias in these results, as unsuccessful funds would have been wound up, but it’s a striking result nonetheless.
The top performing open-ended small cap fund over 10 years is Liontrust UK Smaller Companies, which has turned £1,000 invested into £4,380. That compares with the FTSE Small Cap Index which has turned £1,000 into £2,270, and the FTSE 100 Index which has turned £1,000 invested into £1,550 (source FE, Total Return to 12 Oct 2020).
There are far fewer eyes on the smaller end of the market than on the big blue chips like Unilever and Shell. That throws up opportunities for active managers who can spot tomorrow’s winners, and also avoid the inevitable disasters that pepper the smaller companies indices. Think Debenhams and Patisserie Valerie for companies that simply lost all their equity value.
Is it foolish to invest in British smaller companies right now?
Given the economic damage caused by COVID restrictions, it’s a time when investors might think big is better. And based on recent fund flows, it looks like investors are definitely thinking that outside the UK is better.
No-one has a crystal ball which will tell us how markets perform from here, or indeed when would be the best time to invest. However we can look at historical returns to provide some context, in particular how UK smaller companies fared during the financial crisis.
The chart below shows that if you had invested in June 2007, near the top of the market the average open-ended smaller companies fund would have turned £1,000 invested into £2,418 today. That compares to £1,510 from the FTSE 100 (source FE, Total Return to 12 Oct 2020).
The financial crisis would have been grim. You would have had to have the mettle to watch your investment halve before recovering. But smaller companies did recover, strongly.
Clearly no-one wants to invest just before a 50% fall in the market, and certainly no-one is forecasting that from here. But the point is, even if your timing is lousy, if you take a long term view and are willing to ride out turbulence, smaller companies can still deliver strong returns, given time. A regular monthly investment where you drip feed money into the market smooths out the journey too as you buy in at many price points.
Source: FE, Total Return
The Buffettology approach
The Buffettology Smaller Companies investment trust will be run by Keith Ashworth-Lord and his team at Sanford DeLand Asset Management.
The team run money based on the investment style of Warren Buffett, or “business perspective investing”. The basis for this approach is that investors should treat their portfolio options as if they were becoming full owners of the business they are considering investing in rather than just buying a share of it.
In practice this means the managers look for companies that have a high return on capital, strong free cash flow and highly predictable business performance. Emphasis is placed on well-aligned management, recurring revenue streams and wide economic moats (aka competitive advantage). The managers look to hold for the very long term, in line with Buffett’s advice to only buy something if you were willing to hold it if the market shut down for ten years.
This approach has delivered exceptional returns for investors within the existing SDL UK Buffettology fund, which invests in companies small, medium and large. Since launch in March 2011 the fund is top of the IA UK All Companies sector, having turned £1,000 invested into £3,490. The fund does have greater exposure to small and mid caps than most funds in the sector (see below), but returns have still been impressive despite this tailwind to performance.
Will Buffett’s approach work in smaller companies?
The existing SDL UK Buffettology fund already has a significant weighting to smaller companies, so this isn’t new territory for the team. 47% of the fund is invested in small caps according to Morningstar data, with a further 33% in midcaps (as at 31/07/2020).
There’s no reason why the business perspective approach shouldn’t be equally powerful when analysing smaller companies, and given its high weighting to small caps, the performance of the existing Buffettology fund goes some way to showing that it works in practice.
The Buffettology Smaller Companies trust will run a very concentrated portfolio of 30 to 50 stocks, of up to £500 million in market cap. This high conviction approach can turbo charge returns, but it also means poor performers can have a big negative impact on fund performance, so the pressure is on the process and the managers to get the stock picks right.
Buffett versus Buffettology
Comparing the SDL UK Buffettology fund with Warren Buffett’s Berkshire Hathaway investment company is a bit like comparing an apple with a giant peach but for a bit of fun we thought we’d take a look how they stack up.
Suffice to say the apprentice has beaten the sorcerer over this period. Since the SDL UK Buffettology fund launched in March 2011, it has turned £1,000 invested into £3,490, meanwhile the sagacious one himself has only managed to turn £1,000 invested into £2,560, based on the performance of Berkshire Hathaway (source FE, Sharepad, Total Return).
No doubt Mr Buffett would point out he has a track record dating back to 1965, and that while running a £1 billion fund comes with its trials and tribulations, running a fund worth half a trillion dollars is another level altogether.
Buffettology Smaller Companies Trust key facts
Raising: £100 million to £250 million
Offer price: £1
Offer closes: Friday 23rd October 2020
Market dealing expected to commence: Thursday 29th October 2020
Investment universe: companies between £20 million and £500 million market cap, including AIM stocks, but no unlisted companies.
Objective: to beat the Numis Smaller Companies plus AIM (ex-investment trusts) over the long term
Number of portfolio holdings: expected to be between 30 to 50 companies
Minimum investment amount: £1,000
Ongoing Annual Expenses: 0.96% (estimated)
The trust is available to buy in the offer period or once listed on the market through the AJ Bell Youinvest platform.
Other fund picks
Investors considering investing in the UK Smaller Companies market might also consider the following funds:
Standard Life UK Smaller Companies trust – if you thought ‘the Matrix’ was one of the best action films of all time, think again. It is in fact the proprietary tool of the Standard Life Smaller Companies team which screens the investment universe to provide ideas for research, based on growth, momentum, quality, and valuation metrics. Harry Nimmo’s been at the helm since 1997. Like Buffettology the trust has a focus on quality and growth, and runs a concentrated portfolio of around 50 stocks. The trust has returned 262% over 10 years and trades on a discount of 5.8% to Net Asset Value. The ongoing charge is 0.88%.
Tellworth UK Smaller Companies fund – the investment trust launch may have been pulled but investors can still invest in the open ended fund which has been running since November 2018. While that means the track record is too short to be meaningful, fund manager Paul Marriage has been successfully investing in smaller companies since 2005 at Cazenove and Schroders. The fund likes to invest in companies with strong franchises and pricing power, as well as companies which the team believe are misunderstood or going though change and which has thrown up an opportunity to invest at a favourable price. The ongoing charge is 0.95%.
SDL UK Buffettology or SDL Free Spirit – if you like the cut of the Buffettology jib, and want some exposure to smaller companies, Sanford DeLand already offer two open-ended funds which have a high exposure to the area. Both sit in the IA UK All Companies sector and have some exposure to medium and larger companies too. Free Spirit is more small-cap orientated than UK Buffettology with approximately 70% in smaller companies compared to 47%. UK Buffettology is also £1.4 billion in size, which means it’s going to find it increasingly difficult to take stakes in very small companies; by comparison Free Spirit is less than £25 million in size. The ongoing charges are 1.21% for Free Spirit and 1.19% for UK Buffettology.
Sources: FE, Morningstar and AIC
