Columbia Threadneedle Investments: An eye to the medium term and the value of active management

It’s difficult to look beyond interest rates at the present time. They dominate headlines. They also impact upon every area of economic activity, with a lag, percolating their way through the system. For some small companies, with a greater sensitivity to rising interest rates due to their more limited options for alternative financing structures, navigating such uncertain markets is a tricky endeavour.

As fund managers, we are forced to re-examine the financial strength of The Global Smaller Companies Trust’s portfolio holdings taking account of the higher interest rate costs. This while we are taking a forensic look at the underlying business fundamentals, given the need for companies to carefully manage the interaction between their pricing and costs against an inflationary backdrop. 

In our view, high quality companies with strong balance sheets and a positive track record on cashflow remain best placed to prevail in this environment. Volatile backdrops with uncertain outlooks are also periods when active fund management can add value. Accessing the increased depth of investment research capabilities within the enlarged Columbia Threadneedle Investments business, we have added cautiously to cyclically depressed stocks where we have a positive view on the business model, management team and market position.

There is scope for recovery for some such stocks as and when investor confidence in the overall economic outlook returns. Valuations are also offering some support with several companies that we previously felt were overvalued, now screening more favourably.

While short-term predictions around market trends are hard to time, with an eye to the medium term there is cause for optimism. After an extended period of underperformance, especially on recent comparison with mega-cap US technology stocks, small caps have traditionally shown strong recovery potential when investors start to anticipate improvement in the underlying economic outlook. The outlook for interest rates will be key from here.

New investment ideas and some disposals

Among high-quality businesses offering reliable long-term growth, with valuations de-rated from elevated levels, we have found opportunities in companies including US-based Curtiss-Wright, which designs and manufactures mission critical, precision components and systems for the aerospace, defence, industrial and power generation sectors. The barriers to entry for some of its products, for example in the nuclear power market where safety and reliability are imperative, are high. We believe that the company’s outlook is also supported by a likely continuation of higher production in the aerospace sector as both civil and defence demand increases. There is also potential to gain from the retrofitting and build out of new nuclear power plants.

Accesso Technology Group is another recent entrant in the portfolio. It is a leading provider of virtual queuing, ticketing and point of sale solutions for the global leisure industry. Our investment thesis is supported by highly recurring revenues and software that is integrated into key customer operations, notably within theme parks. Where Accesso’s products and services have enhanced the visitor experience this has in turn led to increased spending, helping the economics of operators.

We presently also have a constructive stance on high quality commodity-exposed businesses predicated on a long period of limited supply growth, new-found capital discipline and the prospect of improving demand from long-term drivers, such as energy transition and the upgrading of both energy and general infrastructure. With this is in mind, we have added two energy related companies to the portfolio: Kosmos Energy and Vitesse Energy.

Kosmos Energy owns and operates attractive oil and gas assets in the Gulf of Mexico and is exposed to a major LNG project in West Africa, with consequentially good production growth prospects. This is driving a strengthening balance sheet as cashflow comes through from the new production. Vitesse Energy was spun out of current portfolio holding Jefferies Financial Group; management here has a good track record of investing in high return energy projects in the US and returning the resulting cashflow to shareholders.

Outside of energy, we have exposure to several companies involved in the build-out of more general infrastructure, such as cement and aggregates supplier Eagle Materials. The company has demonstrated robust pricing power in recent times, with strong local market positions in the parts of the US in which it operates.

Of course, we also need to take the sometimes-painful decision to sell stocks where the original investment thesis no longer holds. Examples of this in the last year include the Gym Group in the UK, where the market outlook has deteriorated because of the cost-of-living crisis and Revolution Beauty, where news of accounting issues and inadequate management and systems persuaded us to exit our holding.

Not to be taken for granted – a happy note on dividends

On a closing point, it is worth mentioning that while capital growth has been hard to come by in recent times, income returns on the trust have been much more positive. Revenue returns per share for the year to 30 April 2023 rose by no less than 28.6% as income from both UK and overseas based holdings grew strongly, helped by the post-pandemic profit bounce-back. Further, following on from the 10.5% increase in the interim dividend, the Board has recommended the payment of a final dividend that takes the full year payment up by 25.0%. This will be the 53rd consecutive increase in the Company’s dividend with a healthy uplift in real terms.

We are not an income fund but are proud of our record of dividend progression, and the fact that our income has been so strong of late is encouraging as it indicates our portfolio management teams are confident about their medium-term prospects.

Find out more about The Global Smaller Companies Trust