Key insights
- Zeroing in on some of the world’s highest-quality smaller companies at inexpensive valuations has generated excellent returns for the trust’s investors.
- Anyone investing for the long term over the past 25 years would have made 11 times their money.
- Historically, times when interest rates start to fall from high levels have been periods of outperformance.
This is just one of the exciting companies from across the world that the trust invests in. The concept is simple: through intensive analysis find high-quality companies trading on inexpensive valuations.
Beyond Stabilus, other examples include Domino’s, the UK pizza chain, and MSC Industrial Direct, a US distributor of metalworking products and services. At first glance, they might not seem to be the most electrifying companies, but viewed through the lens of high quality at a discount they potentially appear to be solid growth businesses, although there are no guarantees.
High quality, low valuations
To explain in more detail, what the trust looks for in a company is straightforward. It seeks high-quality businesses with defining characteristics such as strong competitive advantages, pricing power and financial strength. They should also have strong management, who are highly capable operators, good allocators of the company’s capital and have what is called “skin in the game”. In other words, they have stock options or own shares.
Lastly, the trust wants to invest in stocks at attractive valuations, which is not always easy to do as many of these businesses are well known by the investment community. Valuing a stock or share is an analytical process that involves a range of metrics, most commonly a comparison of a company’s share price to its earnings per share, known as the price / earnings ratio. But the trust is opportunistic, often buying into companies when they are out of favour among investors.
“We take a long-term conservative approach to buying good-quality growing businesses when they become available at an attractive valuation,” says Nish Patel, the trust’s lead fund manager. “We are bottom-up stock pickers. When we look at a business we try to assess the quality of the business model, the management team, the valuation and where the risks are likely to come from.”
Showing that Nish is doing his job well, the investment trust’s metrics paint a picture of companies that are both better quality than other smaller companies and trade on less expensive valuations. This is evident when comparing the trust against its benchmark, a custom index that is used to represent the broad universe of global smaller company stocks.1
Looking first at quality, the average gross profit margin of the trust’s holdings is 36.8%, significantly higher than its custom benchmark’s 31.8%.2 The holdings’ return on equity – a measure of profits earned on capital – is 11.6%, once again substantially higher than the benchmark’s 8.5%. What’s more, on average the trust’s stocks also have less debt than those in the benchmark, which matters in today’s high interest rate environment.
Yet while the trust’s holdings are better quality than the benchmark’s, they also trade on less expensive valuations. When viewed through the lens of the price-to-earnings ratio, the average for the trust’s stocks is 16.5. That compares well with the benchmark’s higher 19.5.
What this means is the trust has done what it set out to: buy high-quality companies at relatively low valuations. Over time, continually investing in this way across the world’s stock markets has generated outstanding returns for shareholders.
“The philosophy and process really does work over the long term,” Nish explains. “Over the last 25 years an investment in the Global Smaller Companies Trust would have seen you make 11 times your money. That’s a lot higher than the smaller company benchmark indices that have gone up between seven times and eight times over the same period. It’s also far ahead of the UK stock market’s flagship FTSE 100 Index of large stocks that has only doubled.”
A promising time
So, what is the current stock market environment for smaller companies? Although the trust has proved an excellent long-term investment, it’s true to say that in the shorter-term smaller companies go in and out of stock market fashion. They typically perform poorly during periods of high interest rates such as the US, UK and Europe have been going through. Right now, smaller companies are trading at far lower valuations than larger stocks, touching deep discounts last reached almost 20 years ago. What followed, though, was a six-year period of substantial outperformance as valuations caught up.
What might the catalyst be for smaller company valuations to catch up again, triggering a golden period for investors in the trust and smaller companies more generally? “We’re excited to think one thing potentially on the horizon is the first interest rate cut in the United States,” Nish explains. “The consensus seems to be that will happen later in 2024, although precise expectations change daily. In the first 12 months after the first cut, smaller companies have historically outperformed larger ones by 10%.”
There can be no guarantees this will happen. But at the end of the day steadily seeking out and investing in some of the most exciting smaller companies around the world has proved highly profitable for anyone fortunate enough to have invested in the trust over the past two decades.
1The benchmark is a blend of the Numis UK Smaller Companies (ex-investment companies) Index and the MSCI AC World ex-UK Small Cap Index.
2Source: Columbia Threadneedle Investments as at 31 January 2024. These numbers refer to the median stock in the portfolio and benchmark.
The Global Smaller Trust discrete annual performance
Discrete annual performance | 2024/ 2023 | 2023/ 2022 | 2022/ 2021 | 2021/ 2020 | 2020/ 2019 |
|---|---|---|---|---|---|
NAV (debt at market value) | 14.24 | -2.73 | -2.60 | 38.41 | -6.73 |
Share price | 17.93 | -5.26 | -7.08 | 43.21 | -10.80 |
Benchmark | 16.13 | -2.92 | -3.18 | 42.85 | -5.21 |
Past performance is not a guide to future performance. Source: Lipper and Columbia Threadneedle Investments. Basis: Percentage growth, total return, bid to bid price with net income reinvested in sterling. The discrete annual performance table refers to 12 month periods, ending 31 May 2024.
Investment Risks
The value of your investments and any income from them can go down as well as up and you may not get back the original amount invested. Gearing is used for investment purposes to obtain, increase or reduce exposure to an asset, index or investment. The use of gearing can enhance returns to investors in a rising market, but if the market falls the losses may be greater.
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