Smaller stocks haven't been this cheap since 2008 - and this fund picks the best ones

  • In Business
  • 2022-12-08 06:00:00Z
  • By The Telegraph

It has been a painful year for investors in Britain's smaller listed companies as the weak pound, political instability, high inflation and the prospect of a lengthy economic slump combined to create a perfect storm.

The fortunes of these businesses tend to be closely tied to the health of the British economy, on which they rely for a larger portion of their revenues than the blue chips of the FTSE 100.

This helps to explain why the Numis Smaller Companies index (which excludes investment trusts) has fallen by 17pc since the start of the year while the FTSE 100 is broadly flat.

Yet in spite of the grim headlines, this column believes there is an important question investors should be asking: how much of this bad news is currently priced in? In the case of Britain's smaller companies, we believe the answer is a huge amount, perhaps too much.

Dan Cartridge of Hawksmoor Investment Management agrees. He says smaller stocks haven't looked this cheap since the depths of the financial crisis in 2008 and significant gains could be on offer for brave investors willing to dip a toe in the water.

With this in mind, the Aberforth Smaller Companies trust, first tipped here in January 2018, looks attractive. Its managers adopt a "value" approach: they buy shares when they are out of fashion and wait for their true worth to be recognised.

This means that while smaller companies look cheap in general, Aberforth's portfolio looks even cheaper. It has an average price‑to‑earnings ratio of 7.7, against 8.8 for the index. The historic average is 13.4 for the index and 11.5 for the trust.

These valuations suggest the market is pricing in a 35pc fall in company earnings across Aberforth's portfolio, akin to a severe recession - something that Cartridge doesn't expect. This means there could be scope for positive surprises. "When valuations have been this low in Aberforth's portfolio, subsequent five‑year annualised returns have been in the region of 20pc to 25pc," he says.

As we enter tough economic times there's also much to be said for the strength of the balance sheets in Aberforth's portfolio. This is testament to the efforts of their management teams to conserve cash during the pandemic. Aberforth has estimated that about 44pc of the trust's holdings have net cash, compared with 37pc of smaller companies in general.

Many also pay a dividend, contributing to the trust's 11‑year record of raising its own divi.

Trading on a discount of 12pc, Aberforth Smaller Companies trust offers investors an attractive entry point to a part of the market that looks undervalued. This column believes that taking advantage of such low valuations should stack the odds in favour of a healthy return over the longer term.

Questor says: buy

Ticker: ASL

Share price at close: £12.90

Update: Chrysalis Investments

Chrysalis, which backs unquoted "disruptive" companies, has cut the performance fee it pays to its fund manager, Jupiter, to 12.5pc on annual returns over an 8pc "hurdle rate". Previously, the performance fee was 20pc. In addition, Chrysalis pays Jupiter an annual management fee of 0.5pc of net assets.

The trust has also sold out of Revolution Beauty, a make‑up brand whose shares had plummeted 90pc before their suspension on the London Stock Exchange. The fund managers, Richard Watts and Nick Williamson, disposed of the stake in an "off‑market" deal worth £5m, which represents an uplift from its nil valuation at the time of the trust's update on net asset values in September.

This is further evidence of the fund managers' efforts to tidy up their portfolio, following a challenging year in which the share price has fallen by 69pc to 77.4p. In September this column said it felt that investors had reached the point of maximum pessimism with Chrysalis - a view we stand by today. Things should continue to improve from here. Hold.

Questor says: hold

Ticker: CHRY

Share price at close: 77.4p 

Read the latest Questor column on every Sunday, Tuesday, Wednesday, Thursday and Friday from 6am.

Read Questor's rules of investment before you follow our tips


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