22 Mar 2024
Peter Ewins, Portfolio Manager, The Global Smaller Companies Trust
After a challenging 2023 for equity investors holding anything other than the narrow band of large US stocks known as the Magnificent 7, there was hope at the end of the year that better times were on their way. While the risk of recessions lingered (in February the UK was confirmed to have slipped into a technical recession in Q4 2023), inflation was coming down and bond yields were falling in the expectation that interest rate cuts were just around the corner. But alas, investors jumped the gun as January saw sentiment sour and equities reverse as one central banker after another extinguished early rate cut hopes.
There is no doubt that rate cuts would be helpful for our investment universe. However, as long-term investors we also know that staying focused on investing in high quality, well managed, smaller companies and avoiding the lure of the latest fashionable investment theme, does pay off. As the chart below shows, the cumulative total return from investing in the shares of The Global Smaller Companies Trust (GSCT) over the last quarter of a century, has significantly exceeded the returns provided by global and UK small and large cap indices.
While in recent years, post the pandemic and renewed excitement in technology stocks, this time AI related, larger cap indices have been in favour, over the longer term the more ardent ability of smaller enterprises to grow has historically translated into greater returns from these stocks.
Small companies often tend to be nimbler than their larger, legacy-entrenched, peers. This lends itself to faster and more effective embracement of advances in new technology and disruptive practices. This of course cannot be taken for granted and we spend a lot of time considering the strengths of the management teams driving each of our investments. In a smaller company the quality of the senior team is critical, as this will tend to be the key determinant as to how well business plans and strategy are executed.
Quality companies
In Europe, we have recently added German company Stabilus to the portfolio. A global leader in the production of intelligent motion control technologies, this innovative and low-cost producer should be a beneficiary of the rising use of this equipment within cars. The company’s capital allocation is moving it towards industrial automation solutions, offering the potential for better returns and a higher valuation.
Aside from an innovative culture, we’re clear in what we believe constitutes a quality company and key areas we look to assess in a potential investment. We want to understand management’s strategy and be confident in its success, evidenced by financial performance. We also demand clarity on a company’s financial position and its cashflows. Trends in metrics we analyse, over a historical period, are designed to evaluate the repeatability of returns and sustainability of competitive advantages.
We often find attractive opportunities in out of favour parts of the markets and over the last 18 months have built up our holding in Workspace Group, a real estate investment trust (REIT). High interest rates and continuing work from home patterns, following the pandemic, have raised concerns about demand for commercial space. Understandably, this has put pressure on real estate capital values.
Workspace serves the London and South East SME (Small/Medium Enterprises) market, providing flexibly leased and individually tailored space across all spectrums of the manufacturing and service sectors. Appealing to such a broad church of businesses means that the dynamics of Workspace Group’s operations stand in contrast to most of the larger, listed, office focused REITs. Workspace’s rental income has been rising nicely as occupancy has recovered post the pandemic, and the company has been increasing its dividend to shareholders. The prevailing unpopularity of the sector presented us with a chance to buy shares at a material discount to the value of the underling property, offering scope for a recovery as interest rates come down.
In North America, we have recently added MSC Industrial Direct, a distributor of industrial consumables to the metalworking and maintenance, repair and overhaul sectors. Despite being a smaller company in terms of market capitalisation, it has strong scale advantages compared to competitors in its market, such as a wider product assortment and superior customer service. This has led to market share gains over time. We believe further growth from here can come from the cyclical recovery in end markets, exposure to the ongoing trend of reshoring manufacturing back to the US, acquisitions of smaller competitors and general operating leverage. We purchased the stock at an attractive valuation in 2022 when slowing global growth and destocking within some industries was making investors cautious about the outlook.
Confidence in the future
While we wait for interest rate cuts to arrive and economic growth to return, we are confident that the companies in our portfolio have strong fundamentals, robust balance sheets and competent management teams, which should stand them in good stead over the long term. Smaller companies have historically tended to do well coming out of a recession and on the back of interest rates falling.
My colleague Nish Patel takes over the helm, as Lead Manager of the Trust, at the end of April. I’ve worked closely with Nish in the run-up to this and he will be well supported by the strong team of smaller company fund managers and the wider investment team at Columbia Threadneedle Investments. As a shareholder myself, I remain confident in the fundamental attractions of the global smaller companies’ asset class for the long term and wish Nish and team all the best in the years to come.
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